(Absorption costing versus variable costing) Williams Company, a wholly owned subsidiary ofJonah, Inc., produces and sells three main product lines. The com¬ pany employs a standard cost accounting system for recordkeeping purposes. At the beginning of 1996, the president of Williams Company presented the budget to the parent company and accepted a commitment to contribute $15,800 to Jonah’s consolidated profit in 1996. The president has been confident that the year’s profit would exceed the budget target, because the monthly sales reports that he has been receiving have shown that sales for the year will exceed budget by 10 percent. The president is both disturbed and confused when the controller presents an adjusted forecast as of November 30, 1996, indicating that profit will be 11 percent under budget. The two forecasts are presented below:

There have been no sales price changes or product mix shifts since the 1/1/96 forecast. The only cost variance on the income statement is the underapplied manufacturing overhead. This amount arose because the company produced only 16,000 standard machine hours (budgeted machine hours were 20,000) during 1996 as a result of a shortage of raw material while the company’s principal supplier was closed for a strike. Fortunately, Williams Company’s finished goods inventory was large enough to fill all sales orders received.

a. Analyze and explain why the profit has declined in spite of increased sales and effective control over costs.

b. What plan, if any, could Williams Company adopt during December to im¬ prove its reported profit at year-end? Explain your answer.

c. Illustrate and explain how Williams Company could adopt an alternative internal cost reporting procedure that would avoid the confusing effect of the present procedure.

d. Would the alternative procedure described in part c be acceptable to Jonah, Inc., for financial reporting purposes? Explain.

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1/1/96 11/30/96 $268,000 $294,800 (212,000) Sales Cost of sales at standard* Gross margin at standard (Under-) overapplied fixed overhead Actual gross margin $ 56,000 -0- $ 56,000 $ 13,400 Selling expenses Administrative expenses Total operating expenses Earnings before tax *Includes fixed manufacturing overhead of $30,000. 26,800 $(40,200) $ 15,800 (233,200) $ 61,600 (6,000) $ 55,600 $ 14,740 26,800 $(41,540) $ 14,060