Case study 1

Empire Glass Works, manufactures and sells high quality glass bottles for industrial use. The company at present reports profits on marginal costing basis. However, Tom Cuck (the management accountant of Empire Glass Works) is not in support of continuing the use of marginal costing system due to the high fixed costs associated with the glass container industry and a substantial difference between sales volume and production in some months. Tom proposes to the top management that it would be more appropriate for the company to report profits based on absorption costing.

Budgeted cost per bottle is as follows:

Particulars

Amount ($)

Direct materials

8.50

Direct labour

7.00

Other variable production costs

3.16

Total annual fixed production overhead was budgeted at $5,784,000 and the annual budgeted production was 1,430,000 bottles. However, due to the nature of the demand, the monthly budgeted production from January to April was 25% lower than that of the monthly budgeted production from May to December. The actual fixed overhead cost incurred was as budgeted.

Further information:

Particulars

April

May

Bottles sold

87,000

135,000

Bottles produced

75,000

132,000

Selling price per bottle

$32

$32

Fixed selling expenses

$115,000

$115,000

Fixed administrative expenses

$75,000

$75,000

The inventory balance as of 31st of May was 2,500 bottles.

Required:

(a) Prepare income statements for the months of April and May as per absorption costing. [7 marks]

(b) Prepare income statements for the months of April and May as per marginal costing. [7 marks]

(c) If you are the management accountant of Empire Glass Works, list three reasons in support your proposal to report profits using absorption costing. [6 marks]