(Absorption costing versus variable costing) Virginia Company, a wholly owned subsidiary of Bluebeard, Inc., produces and sells three main product lines. The company employs a standard cost accounting system for recordkeeping purposes.

At the beginning of 1999, the president of Virginia Company presented the budget to the parent company and accepted a commitment to contribute

$15,800 to Bluebeard’s consolidated profit in 1999. 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, 1999, indicating that profits will be 11 percent under budget. The two forecasts follow:

1/1/99 11/30/99 Sales $268,000 $294,800 Cost of sales at standard* (212,000) (233,200)
Gross margin at standard $ 56,000 $ 61,600 (Under-) overapplied fixed overhead 0 (6,000)
Actual gross margin $ 56,000 $ 55,600 Selling expenses $ 13,400 $ 14,740 Administrative expenses 26,800 26,800 Total operating expenses $ (40,200) $ (41,540)
Earnings before tax $ 15,800 $ 14,060 *Includes fixed manufacturing overhead of $30,000.
There have been no sales price changes or product mix shifts since the 1/1/99 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 1999 as a result of a shortage of raw material while the company’s principal supplier was closed because of a strike. Fortunately, Virginia 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 Virginia Company adopt during December to improve its reported profit at year-end? Explain your answer.

c. Illustrate and explain how Virginia 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 Bluebeard, Inc., for financial reporting purposes? Explain.