Absorption vs Variable (Contribution Method) Costing

Anthony, Inc.

Alice Williams, the founder of Anthony, Inc. was previously a researcher at the University of Florida in the Veterinary School. She discovered a compound that prevents, ticks, fleas, and heartworms from infecting dogs and that can be added as a powder to a dogs food. More importantly, dogs love it. There is no longer a problem persuading dogs to take their preventive medication.

Alice is involved in a number of other projects and does not want to run the company she has set up to produce and market the new product. She has invested in setting up the business and has hired a general manager to oversee operations. She has created the following compensation plan for her manager.

Management Incentive Plan

Executive Compensation: The General Manager will be paid a monthly bonus equal to 10% of the Income from Operations

In the first month of operations, the company had the following results:

Performance Report: December, 2018

Units: produced 30,000; sold 20,000;

Selling Price: $20 per unit

Beginning inventory 0 (zero) units.

Variable Costs:

Direct Materials $5 per unit

Direct Labor $3 per unit

Variable Manufacturing Overhead $1 per unit

Variable Selling and Administrative Costs $2 per unit

Fixed Costs:

Manufacturing Overhead $120,000 per month

Selling and Administrative Costs $15,000 per month

Required:

Alice has asked you to help her calculate the companys Income from Operations for the first month.

You tell her it can be done in two ways: The Full Absorption Costing approach or the Contribution Method approach.

1. She asks you to show her both methods and explain the benefits and disadvantages of each.

2. She also asks you to recommend which one she should use,
   1. based on this months performance alone, and
   2. based on long term projections for a successful business.

For (a) and (b) above, state your reasons.