Monteplana Ltd produced the following financial statement for the year ended 31 December 19_3:

There were no opening or closing stocks of either finished goods or workin-
progress. The factory plant had a production capacity of 200 000 units per annum.
As a result of the net loss arising in 19_3, the sales director maintained that the loss had arisen through not operating the plant at full capacity and that an extensive advertising campaign would increase sales significantly. Thus the board of directors agreed that £40 000 would be spent on an advertising campaign in 19_4, and that the plant would be worked to full capacity producing 200 000 units.
The following results were achieved in the financial year ended 31 December 19_4.
(1) 130 000 units were sold at the 19_3 price.
(2) All factory variable expenses increased directly in proportion to output.
(3) There was no increase in selling and administrative expenses except that due to increased advertising.
All the directors agreed that in order to pursue a policy of consistency, stocks of finished goods should continue to be valued at the full manufacturing unit cost.
The accountant stated that he would prefer to see stock valuation including manufacturing variable costs only.

Required:

(a) An income statement for the year ended 31 December 19_4 on the agreed basis of valuing stocks.

(b) An alternative income statement for the year ended 31 December 19_4 using the accountant’s suggestion as the basis of valuing stock. (5 marks)

(c) (i) Use accepted accountancy principles to explain the ‘correctness’ of the argument regarding the stock valuation of the directors.
(ii) Write a memorandum which the accountant could submit to the directors in an effort to persuade them to change to his policy for stock valuation. The memorandum should explain the shortcomings of the present policy and the advantages which would accrue from the change.

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Sales (100,000 units) Less Direct materials 300 000 100 000 Direct labour 40 000 Variable factory overhead 10 000 Fixed factory overhead 100 000 250 000 Manufacturing profit 50 000 Less Selling and distribution expenses 30 000 Administrative expenses 30 000 60 000 Net Loss 10 000