LO 18-3, 18-4] 18-46 Profit Centers: Comparison of Variable and Full Costing (Underapplied Overhead) Mark Hancock, Inc., manufactures a specialized surgical instrument called the HAN-20. The firm has grown rapidly in recent years because of the product's low price and high quality. However, sales have declined this year due primarily to increased competition and a decrease in the surgical procedures for which the HAN-20 is uscd. The firm is concerned about the decline in sales and has hired a consultant to analyzc thc firm's profitability. The consultant has provided the following information 2015 Sales (units) 3,200 3,800 4,000 2,800 2,300 3,400 1,400 Production Budgeted production and sales Beginning inventory Data per unit (all variable) $2,095 1,200 125 Price Direct materials and labor Selling costs $1,995 1,200 125 Fixed costs Manufacturing overhead Selling and administrative S700,000 120,000 S595,000 120,000 Top management at Hancock explained to the consultant that the unfavorable economic climate in 2015 and 2016 had caused the firm to reduce its price and production levels and reduce its fixed manufacturing costs in responsc to the declinc in sales. Even with the price reduction there was a decline in sales in both years. This led to an increase in inventory in 2015, which the firm was able to reduce in 2016 by further reducing the level of production. In both years Hancock's actual pro- duction was less than the budgeted level so that the overhcad rate for fixed overhcad, calculated from budgeted production levels, was too low and a production volume variance was calculated to adjust cost of goods sold for the underapplied fixed overhead (the calculation of the production volume variance is explained fully in Chapter 15, and reviewed briefly below) The production volume variance for 2015 was determincd from the fixed overhcad ratc of $175 per unit ($700,000/4,000 budgeted units). Since the actual production level was 200 units short of the bud- geted level in 2015 (4,000 3,800), the amount of the production volume variance in 2015 was 200 $175 $35,000. The production volume variance is underapplied (since actual production level is less than budgeted) and is therefore added back to cost of goods sold to determine the amount of cost of goods sold in the full-cost incomc statement. The full-cost income statement for 2015 is shown bclow: $6,704,000 Sales Cost of goods sold Beginning inventory $1,100,000 5,225,000 S6,325,000 1,925,000 Cost of goods produced Cost of goods available for sale Less ending inventory Cost of goods sold $4,400,000 Plus underapplied production volume variance Adjusted cost of goods sold Gross margin Less selling and administrative costs 35,000 $4,435,000 $2,269,000 S 400,000 120,000 Variable 520,000 $1,749,000 Operating income Required 1. Using the full-cost method, prepare the income statements for each year 2. Using variable costing, prepare an income statement for cach period, and explain the difference in opcrating income from that obtained in requirement I 3. Write a brief memo to the firm to explain the difference in operating income between variable costing and full costing
