(3)

,

Headsmart a three-year-old company, has been producing and selling a single type of bicycle helmet. Headsmart uses standard costing. After reviewing the statements of comprehensive income for the first three years, Stuart Weil, president of Headsmart, commented, "I was told by our accountantsand in fact, I have memorizedthat our breakeven volume is 50,00 units. I was happy that we reached that sales goal in each of our first two years. But, here's the strange thing. in our first year, we sold 50,000 units and indeed we broke even. Then, in our second year, we sold the same volume and had a positive operating income. I didn't complain, of course. . . but here's the bad part. In our third year, we sold 20% more helmets, but our operating income fell by more than 80% relative to the second year! We didn't change our selling price or cost structure over the past three years and have no price, efficiency, or rate variances . . . so what's going on?!"

Absorption Costing

	2017	2018	2019
Sales (units)	50,000	50,000	60,000
Revenues	$2,100,000	$2,100,000	$2,520,000
Cost of goods sold:
Beginning inventory	0	0	380,000
Production	1,900,000	2,280,000	1,900,000
Available for sale	1,900,000	2,280,000	2,280,000
Deduct ending inventory	0	(380,000)	0
Adjustment for production-volume variance	0	(240,000)	0
Cost of goods sold	1,900,000	1,660,000	2,280,000
Gross margin	200,000	440,000	240,000
Selling and administrative expenses (all fixed)	200,000	200,000	200,000
Operating income	$0	$240,000	40,000

Beginning inventory	0	0	10,000
Production (units)	50,000	60,000	50,000
Sales (units)	50,000	50,000	60,000
Ending inventory	0	10,000	0
Variable manufacturing cost per unit	$14	$14	$14
Fixed manufacturing overhead costs	$1,200,000	$1,200,000	$1,200,000
Fixed manuf. costs allocated per unit produced	$24	$24	$24

1.	What denominator level is Headsmart using to allocate fixed manufacturing costs to the bicycle helmets? How is Headsmart disposing of any favourable or unfavourable production-volume variance at the end of the year? Explain your answer briefly.
2.	How did Headsmart's accountants arrive at the breakeven volume of 50,000 units?
3.	Prepare a variable-costing-based statement of comprehensive income for each year. Explain the variation in variable costing operating income for each year based on contribution margin per unit and sales volume.
4.	Reconcile the operating incomes under variable costing and absorption costing for each year, and use this information to explain to Stuart Weil the positive operating income in 2018 and the drop in operating income in 2019.