5-A1 Straightforward Income Statements

The Liberty Company had the following manufacturing data for the year 2012 (in thousands of dollars):

Beginning and ending inventories	None
Direct material used	$410
Direct labor	330
Supplies	25
Utilitiesvariable portion	42
Utilitiesfixed portion	17
Indirect laborvariable portion	93
Indirect laborfixed portion	51
Depreciation	215
Property taxes	18
Supervisory salaries	59

Selling expenses were $296,000 (including $76,000 that were variable) and general administrative expenses were $149,000 (including $21,000 that were variable). Sales were $2.5 million.

Direct labor and supplies are regarded as variable costs.

Prepare two income statements, one using the contribution approach and one using the absorption approach.

Suppose that all variable costs fluctuate directly in proportion to sales and that fixed costs are unaffected over a very wide range of sales. What would operating income have been if sales had been $2.3 million instead of $2.5 million? Which income statement did you use to help obtain your answer? Why?

5-A4 Target Costing

Dans Discount Corporation uses target costing to aid in the final decision to release new products to production. A new product is being evaluated. Market research has surveyed the potential market for this product and believes that its unique features will generate a total demand over the products life of 65,000 units at an average price of $380. The target costing team has members from market research, design, accounting, and production engineering departments. The team has worked closely with key customers and suppliers. A value analysis of the product has determined that the total cost for the various value-chain functions using the existing process technology are as follows:

Value-Chain Function	Total Cost over Product Life
Research and development	$ 2,100,000
Design	250,000
Manufacturing (40% outsourced to suppliers)	5,000,000
Marketing	1,400,000
Distribution	1,500,000
Customer service	3,070,000
Total cost over product life	$13,320,000

Management has a target contribution to profit percentage of 50% of sales. This contribution provides sufficient funds to cover corporate support costs, taxes, and a reasonable profit.

Should the new product be released to production? Explain.

Approximately 40% of manufacturing costs for this product consists of materials and parts that are purchased from suppliers. Key suppliers on the target-costing team have suggested process improvements that will reduce supplier cost by 15%. Should the new product be released to production? Explain.

New process technology can be purchased at a cost of $220,000 that will reduce non-outsourced manufacturing costs by 30%. Assuming the suppliers process improvements and new process technology are implemented, should the new product be released to production? Explain.

5-B1 Contribution and Absorption Income Statements

The following information is taken from the records of the Zealand Manufacturing Company for the year ending December 31, 2012. There were no beginning or ending inventories.

Sales	$14,000,000	Long-term rent, factory	$ 85,000
Sales commissions	470,000
Advertising	430,000	Factory superintendents salary	31,000
Shipping expenses	320,000	Factory supervisors salaries	105,000
		Direct materials used	3,500,000
Administrative executive salaries	100,000	Direct labor	1,700,000
		Cutting bits used	53,000
Administrative clerical salaries (variable)	370,000	Factory methods research	42,000
		Abrasives for machining	99,000
Fire insurance on factory equipment	4,000	Indirect labor	950,000
Property taxes on factory equipment	26,000	Depreciation on factory equipment	430,000

1. Prepare a contribution income statement and an absorption income statement. If you are in doubt about any cost behavior pattern, decide on the basis of whether the total cost in question will fluctuate substantially over a wide range of volume. Prepare a separate supporting schedule of indirect manufacturing costs subdivided between variable and fixed costs.

2. Suppose that all variable costs fluctuate directly in proportion to sales, and that fixed costs are unaffected over a wide range of sales. What would operating income have been if sales had been $12 million instead of $14 million? Which income statement did you use to help get your answer? Why?