Effect of Changes in Production and Costing Method on Operating Profit ("I Enjoy Challenges"): (This is a classic problem based on an actual company's experience.) The X. B. Company uses an actual cost system to apply all production costs to units produced. While the plant has a maximum production capacity of 40 million units, only 10 million units were produced and sold during Year 1. There were no beginning or ending inventories. The X. B. Company income statement for Year 1 is as follows:

The board of directors is concerned about this loss. A consultant approached the board with the following offer: "1 agree to become president for no fixed salary. But 1 insist on a year-end bonus of 10 percent of operating profit (before considering the bonus)." The board of directors agreed to these terms, and the consultant was hired. The new president promptly stepped up production to an annual rate of 30 million units. Sales for Year 2 remained at 10 million units. The resulting X. B. Company income statement for Year 2 follows.

The day after the statement was verified, the president took his check for $700,000 and resigned to take a job with another corporation. He remarked. "I enjoy chal- lenges. Now that X. B. Company is in the black. I'd prefer tackling another challeng- ing situation." (His contract with his new employer is similar to the one he had with X. B. Company.)

Required:

a. What is your evaluation of the Year 2 performance?

b. Using variable costing, what would operating profit be for Year 1? For Year 2? What are the inventory values? (Assume all marketing and administrative costs are fixed.) Compare those results with the full-absorption statements shown above.

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X. B. COMPANY Income Statement For the Year Ending December 31, Year 1 Sales (10,000,000 units at $3) $30,000,000 Cost of goods sold: Variable (10,000,000 at $1) $10,000,000 Fixed 24,000,000 34,000,000 Gross margin Marketing and administrative costs. Operating profit (loss) (4,000,000) 5,000,000 $ (9,000,000)