Gates Video Games manufactures video game machines. Market saturation and technological innovations have caused pricing pressures that have resulted in declining profits. To stem the slide in profits until the company can introduce new products, top management has turned its attention to both manufacturing economies and increased production. To realized these objectives, management developed an incentive program to reward production managers who contribute to an increase in the number of units produced and achieved cost reduction. In addition, the company institute a Just in time (JIT) purchasing program so that it purchases raw materials on as needed basis.

The production managers have responded to the pressure to improve manufacturing performance in several ways that have resulted in an increase over normal production levels. The video game machines put together by the assembly group required parts from both the printed circuit boards (PCB) and the reading heads (RH) departments. To attain increased production levels, the PCB and RH departments started rejecting parts from suppliers that previously would have been tested and modified to meet manufacturing standards. Preventive maintenance on machines used in the production of these parts has been postponed with only emergency repair work being performed to keep production lines moving. The maintenance staff is concerned that there will be serious breakdown and unsafe operating conditions.

The more aggressive assembly group production supervisors have pressured maintenance personnel to attend to their machines at the expense of other groups. This has resulted in machine downtime in the PCB and RH departments which, when coupled with demands for accelerated parts delivery by the assembly department, has led to more frequent parts rejection and increased friction among departments. Gates Video Games operates under a standard costing system. The standard costs at a production level of 24,000 units per year are in presented Table 1.

Gates Video Games prepares monthly income statements based on actual expenses. Part B of Table 1 shows the statement for May, when production and sales both reached 2,200 units. The budgeted sales price was $200 per unit, and budgeted (normal) production and sales were 24,000 units per year. Top management was surprised by the low profit in spite of increased sales for May. The original budget had called for income before taxes of $62,000, and with the added sales, the president had expected at least $68,000 of income ($6,200 more income; 200 extra units x $31 per unit).

The president called on Michelle Barber, director of cost management, to report on the reasons for the shortfall in income. After a thorough review of the data, Barber prepared the report in part C of Table 1.

Table 1 STANDARD COST PER UNIT

Quantity Cost Total

A. Standard Cost Report

Direct materials:

Housing unit 1 unit $ 20 $ 20

Printed circuit boards (PCB) 2 boards 15 30

Reading heads (RH) 4 heads 10 40

Direct Labor:

Assembly department 2 hours 8 16

PCB department 1 hour 9 9

RH department 1.5 hours 10 15

Overhead:

Variable 4.5 hours 2 9

Fixed 4.5 hours 4 18

Total manufacturing cost per unit $ 157

Selling and administrative: Fixed 12 12

Total standard cost per unit $ 169

B. Income Statement for May

Revenues (2,200 units) $ 440,000

Variables\ costs:

Direct materials $ 220,400

Direct labor 93,460

Variable overhead 18,800

Fixed costs:

Overhead 37,600

Selling and Administrative 22,600

Total costs 392,260

Income before taxes $ 47,740

C. Usage Report for May

Cost item Actual Quantity Actual Cost

Direct materials:

Housing units 2,200 units $ 44,000

Printed circuit boards 4,700 boards 75,200

Reading heads 9,200 heads 101,200

Direct labor:

Assembly department 3,900 hours 31,200

PCB department 2,400 hours 23,760

RH department 3,500 hours 38,500

Overhead:

Variable 18,800

Fixed 37,600

Total manufacturing costs $ 370, 260

Required:

1. make a budgeted income statement in contribution margin format for Gates Video Games showing why the company expected income before taxes to be $62,000.
2. Assume that you have been given Michelle Barber's task. make an analysis explaining the reason for the difference between the original projected income before taxes $ 62,000 and the actual of $47,740. Compute all the variances that are helpful what you learn from the variances. in explaining this difference, and explain