Arequipa Enterprises (AE) began as a maker of industrial drafting equipment. After several successful years, the company has graduated into making two popular products: a plotter and a 3D printer. Both products have the same variable costs as shown below.

Variable costs per unit:

Direct materials

$ 70

Direct labour

$130

Variable manufacturing overhead

$ 30

Sales Commission

$ 20

Total

$250

In order to maintain good customer service, AE keeps about 500 units of each product on hand as warehouse inventory.

The company has a long-term contract to rent manufacturing equipment and necessary space for $9,000,000 per year. General & administrative costs amount to $2,100,000 per year.

Costs and unit sales are expected to be consistent from last year to the current year. Based on last years' results, AE expects to sell 10,000 units of each product this year. The plotters are priced at $800 and the 3D printers at $1,000.

Rachel Merrett, president of the company, is considering how best to motivate her managers. She feels it is fair to provide bonuses once the company's operating income is 5% above the expected operating income.

Required:

1. Prepare a contribution format income statement for AE using variable costing.
2. Prepare an income statement for AE using absorption costing.
3. Based on Rachel's approach, what is the operating income level that AE must generate before managers are eligible for bonuses?
5. Rachel can specify the use of either the contribution format income statement or the absorption costing income statement in defining the bonus threshold. Which would you recommend she use? Explain why.