Income Statements underAbsorptionandVariable Costing

The demand for aloe vera hand lotion, one of numerous products manufactured by Smooth Skin Care Products Inc., has dropped sharply because of recent competition from a similar product. The companys chemists are currently completing tests of various new formulas, and it is anticipated that the manufacture of a superior product can be started on March 1, one month in the future. No changes will be needed in the present production facilities to manufacture the new product because only the mixture of the various materials will be changed.

The controller has been asked by the president of the company for advice on whether to continue production during February or to suspend the manufacture of aloe vera hand lotion until March 1. The controller has assembled the following pertinent data:

The production costs and selling and administrative expenses, based on production of 400,000 units in January, are as follows:

Sales for February are expected to drop about 20% below those of the preceding month. No significant changes are anticipated in the fixed costs or variable costs per unit. No extra costs will be incurred in discontinuing operations in the portion of the plant associated with aloe vera hand lotion. The inventory of aloe vera hand lotion at the beginning and end of February is expected to be inconsequential.

Required:

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Hint(s)

1. Prepare an estimated income statement in absorption costing form for February for aloe vera hand lotion, assuming that production continues during the month.

Smooth Skin Care Products Inc.
Estimated Income StatementAbsorption CostingAloe Vera Hand Lotion
For the Month Ending February 28, 2014
	$
Cost of goods sold:
	$
	$
Selling and administrative expenses:
	$
	$

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1. Under absorption costing, the cost of goods sold includes direct materials, direct labor, and factory overhead costs. Both fixed and variable factory costs are included as part of factory overhead.

Learning Objective 1andLearning Objective 2.

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Hint(s)

2. Prepare an estimated income statement in variable costing form for February for aloe vera hand lotion, assuming that production continues during the month.

Smooth Skin Care Products Inc.
Estimated Income StatementVariable CostingAloe Vera Hand Lotion
For the Month Ending February 28, 2014
	$
Variable cost of goods sold:
	$
	$
	$
Fixed costs:
	$
	$

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2. Under variable costing, the cost of goods sold includes only variable manufacturing costs.

Learning Objective 1andLearning Objective 2.

Hint(s)

3. What would be the estimated loss in income from operations if the aloe vera hand lotion production were temporarily suspended for February? $

4. Production of A.V. lotion should beSelectcontinueddiscontinuedCorrect 2 of Item 3. Temporary suspension of production would result in an operating loss ofSelect$840,000$1,800,000Correct 3 of Item 3compared with an operating loss ofSelect$840,000$1,800,000Correct 4 of Item 3if production is continued. The result would be a savings ofSelect$840,000$960,000Correct 5 of Item 3.

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3. The estimated loss is calculated by adding the fixed manufacturing cost plus the fixed selling and administrative costs.

4. Keep in mind that in the short run, fixed costs cannot be avoided.