Based on the below CASE of LANDAU Company, you are required to answer ALL of the

following QUESTIONS:

1. Discuss the main issues faced by Landau Company? (15 points)

2. Explain the reasons (and show your work) for the $29,287 difference in July between the incomes before taxes under the two different methods. (20 points)

3. Critique the various pros and cons of the variable costing proposal that were presented in the meeting. (20 points)

Landau Company

In early August, Terry Silver, the new marketing vice president of Landau Company, was studying the July income statement. Silver found the statement puzzling: Julys sales had increased significantly over Junes, yet income was lower in July than in June. Silver was certain that margins on Landaus products had not narrowed in July and therefore felt that there must be some mistake in the July statement.

When Silver asked the companys chief accountant, Meredith Wilcox, for an explanation, Wilcox stated that production in July was well below standard volume because of employee vacations. This had caused overhead to be under-absorbed, and a large unfavorable volume variance had been generated, which more than offset the added gross margin from the sales increase. It was company policy to charge all variances to the monthly income statement, and these production volume variances would all wash out by years end, Wilcox had said.

Silver, who knew little about accounting, found this explanation to be incomprehensible. With all the people in your department, I dont understand why you cant produce an income statement that reflects the economics or our business. In the company that I left to come here, if sales went up, profits went up. I dont see why that shouldnt be the case here, too.

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EXAMINATION QUESTION BOOKLET

DIN: RUW-SNT-T-035 RN: 04

ED: 18/02/2016

As Wilcox left Silvers office, a presentation at a recent Institute of Management Accountants meeting came to mind. At that meeting the controller of Winjum Company had described that firms variable costing system, which charged fixed overhead to income as a period expense and treated only variable production costs as inventoriable product costs. Winjums controller had stressed that, other things being equal, variable costing caused income to move with sales only, rather than being affected by both sales and production volume as was the case with full absorption costing systems.

Wilcox decided to recast the June and July income statements and balance sheets using variable costing. (The income statement as recast and as originally prepared is shown in Exhibit 1.) Wilcox then showed these statements to Terry Silver, who responded, Now thats more like it! I knew July was a better month for us than June, and your new variable costing statements reflect that. Tell your boss [Landaus controller] that at the next meeting of the executive committee Im going to suggest we change to this new method.

At the next executive committee meeting, Silver proposed adoption of variable costing for Landaus monthly internal income statements. The controller also supported this change, saying that it would eliminate the time-consuming efforts of allocating fixed overhead to individual products. These allocations had only led to arguments between product managers and the accounting staff. The controller added that since variable costing segregated the cost of materials, direct labor, and variable overhead from fixed overhead costs, managements cost control efforts would be enhanced.

Silver also felt that the margin figures provided by the new approach would be more useful than the present ones for comparing the profitability of individual products. To illustrate the point, he had worked out an example. With full costing, two products in Landaus line, numbers 129 and 243, would appear as follows:

Product

129 243

Standard Production Cost

$2.54 3.05

Selling Price

$4.34 5.89

Unit Margin

$1.80 2.84

Margin Percent

41.5 48.2

Thus, product 243 would appear to be the more desirable one to sell. But on the proposed basis, the numbers were as follows:

Product

129 243

Standard Production Cost

$1.38 2.37

Selling Price

$4.34 5.89

Unit Margin

$2.96 3.52

Margin Percent

68.2 59.8

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EXAMINATION QUESTION BOOKLET

DIN: RUW-SNT-T-035 RN: 04

ED: 18/02/2016

According to Silver, these numbers made it clear that product 129 was the more profitable. At this point, the treasurer spoke up. If we use this new approach, the next thing we want to know would be what marketing will be required to continue selling at your usual mark-up over variable costs. How are we going to pay the fixed costs then? Besides, in my 38 years of experience, its the lack of control over long-run costs that can bankrupt a company. Im opposed to any proposal that causes us to take a myopic view of costs.

The president also had some concerns, having further considered the proposal. In the first place, if I add together the June and July pre-tax profit under each of these methods, I get almost $117,000 with the present method, but only $99,000 under the proposed method. While Id be happy to lower our reported profits from the standpoints of relations with our employee

union and income taxes, I dont think its a good idea as far as our owners and bankers are concerned. And I share Jamies [the treasurers] concern about controlling long-run costs. I think we should defer a decision on this matter until we fully understand all of the implications.

===============================================================================

Exhibit 1.

Sales Revenue

Cost of sales

Gross margin

Fixed production overhead Selling and administrative Income before taxes

Variable Costing

$865,428 337,756 $527,672 192,883 301,250

$33,539

July

Absorption Costing

$931,710 521,758 $346,163

310,351

$35,812

Variable Costing

$931,710 363,367

$568,333

192,883 310,351 $65,099

LANDAU COMPANY

Income Statements Items for June and July

June

Absorption Costing

$865,428 483,149 $382,279

301,250

$81,029

Based on the below CASE of LANDAU Company, you are required to answer ALL of the following QUESTIONS: 1. Discuss the main issues faced by Landau Company? (15 points) 2. Explain the reasons (and show your work) for the $29,287 difference in July between the incomes before taxes under the two different methods. (20 points) 3. Critique the various pros and cons of the variable costing proposal that were presented in the meeting. (20 points) Landau Company In early August, Terry Silver, the new marketing vice president of Landau Company, was studying the July income statement. Silver found the statement puzzling: July's sales had increased significantly over June's, yet income was lower in July than in June. Silver was certain that margins on Landau's products had not narrowed in July and therefore felt that there must be some mistake in the July statement When Silver asked the company's chief accountant, Meredith Wilcox, for an explanation, Wilcox stated that "production in July was well below standard volume because of employee vacations. This had caused overhead to be under-absorbed, and a large unfavorable volume variance had been generated, which more than offset the added gross margin from the sales increase. It was company policy to charge all variances to the monthly income statement, and these production volume variances would all wash out by year's end, Wilcox had said. Silver, who knew little about accounting, found this explanation to be "incomprehensible." "With all the people in your department, I don't understand why you can't produce an income statement that reflects the economics or our business. In the company that I left to come here, if sales went up, profits went up. I don't see why that shouldn't be the case here, too". As Wilcox left Silver's office, a presentation at a recent Institute of Management Accountants meeting came to mind. At that meeting the controller of Winjum Company had described that firm's variable costing system, which charged fixed overhead to income as a period expense and treated only variable production costs as inventoriable product costs. Winjum's controller had stressed that, other things being equal, variable costing caused income to move with sales only, rather than being affected by both sales and production volume as was the case with full absorption costing systems. Wilcox decided to recast the June and July income statements and balance sheets using variable costing. (The income statement as recast and as originally prepared is shown in Exhibit 1.) Wilcox then showed these statements to Terry Silver, who responded, "Now that's more like it! I knew July was a better month for us than June, and your new "variable costing" statements reflect that. Tell your boss [Landau's controller] that at the next meeting of the executive committee I'm going to suggest we change to this new method". At the next executive committee meeting, Silver proposed adoption of variable costing for Landau's monthly internal income statements. The controller also supported this change, saying that it would eliminate the time-consuming efforts of allocating fixed overhead to individual products. These allocations had only led to arguments between product managers and the accounting staff. The controller added that since variable costing segregated the cost of materials, direct labor, and variable overhead from fixed overhead costs, management's cost control efforts would be enhanced. Silver also felt that the margin figures provided by the new approach would be more useful than the present ones for comparing the profitability of individual products. To illustrate the point, he had worked out an example. With full costing, two products in Landau's line, numbers 129 and 243, would appear as follows: Product 129 Standard Production Cost Selling Price Unit Margin $4.34 $1.80 3.05 5.89 2.84 $2.54 Margin Percent 41.5 48.2 243 Thus, product 243 would appear to be the more desirable one to sell. But on the proposed basis, the numbers were as follows: Product 129 Standard Production Cost $1.38 Selling Price Unit Margin Margin Percent $4.34 $2.96 68.2 243 2.37 5.89 3.52 59.8 According to Silver, these numbers made it clear that product 129 was the more profitable. At this point, the treasurer spoke up. "If we use this new approach, the next thing we want to know would be what marketing will be required to continue selling at your usual mark-up over variable costs. How are we going to pay the fixed costs then? Besides, in my 38 years of experience, it's the lack of control over long-run costs that can bankrupt a company. I'm opposed to any proposal that causes us to take a myopic view of costs". The president also had some concerns, having further considered the proposal. In the first place, if I add together the June and July pre-tax profit under each of these methods, I get almost $117,000 with the present method, but only $99,000 under the proposed method. While I'd be happy to lower our reported profits from the standpoints of relations with our employee union and income taxes, I don't think it's a good idea as far as our owners and bankers are concerned. And I share Jamie's (the treasurer's] concern about controlling long-run costs. I think we should defer a decision on this matter until we fully understand all of the implications. Exhibit 1. LANDAU COMPANY Income Statements Items for June and July June Absorption Costing Variable Costing July Absorption Costing Variable Costing Sales Revenue $865,428 $865,428 $931,710 $931,710 Cost of sales 483,149 337.756 521,758 363,367 Gross margin $382,279 $527,672 $346,163 $568,333 Fixed production overhead 192,883 192,883 Selling and administrative 301,250 301,250 310,351 310,351 Income before taxes $81,029 $33,539 $35,812 $65,099