Monitors-4-Us (M4U) manufactures a monitor called the ULTRA-Low. The ULTRA-Low monitor is designed specifically to reduce eyestrain by using a low blue light filter and flicker free technology. They market their product to online retailers who sell to home office workers requiring good monitors at a midrange price to reduce eyestrain.

M4U's management team is determining manufacturing budgets for 2020 and has set the following standards for each monitor:

Direct materials,$24.00

Direct manufacturing labour, $14.00

Variable manufacturing overhead, $ 5.00

Fixed annual manufacturing costs for the year are budgeted for $1,440,000.

Effective use of capacity is a key strategic focus of the organization. As such, M4U ensures the appropriate denominator level is used when assessing its capacity usage of resources and accountability to its stakeholders. The following paragraph describes the management team's discussion relating to this.

Denominator activity levels:

To satisfy demand for the 2020 year the vice-president of production plans to produce 47,000 monitors. However, the marketing manager has identified that the demand between 2017 and 2019 has averaged 45,000 monitors per year. M4U's manufacturing plant has the capacity to produce 60,000 monitors annually assuming the plant is operating 365 days of the year. However, taking into consideration usual closures for such situations as weekends, holidays, and sick time, it is more likely the plant could produce 48,000 monitors annually.

Required:

In preparation for 2020:

a.Based on the descriptions in the paragraph titled, "Denominator activity levels" above, state the production level of monitors that is related to master budget capacity. Explain when this level of capacity is used to calculate inventory cost. (2 marks)

b.State which of the production levels described in the paragraph titled "Denominator activity levels" represents practical capacity. Explain what decisions can be made when overhead is applied using practical capacity. (2 marks)

QUESTION 4 - (continued)

At end of 2020:

At the end of 2020 management is eager to determine profitability as bonuses are paid to senior managers using return on investment. It was determined that actual production for the year was 46,000 monitors and 40,000 monitors were sold. At the beginning of the year there were 1,500 monitors in inventory and unsold monitors were recorded on the balance sheet at standard cost.

All product costs for 2020 were at standard costs determined at the beginning of the year. As such there are no price, efficiency, or rate variances. Any production volume variance is written off to the cost of goods sold for the year. Standard product costs were the same for 2019.

Variable selling and administrative expenses were $14.00 per monitor sold. Fixed selling and administrative expenses were $258,000. The selling price per monitor was $110.00

c.M4U's controller is concerned about the rising levels of inventory. As such, she asks you to assess the 2020 operating income by preparing the following:

i.An income statement using absorption costing in the gross margin format. Use the normal level of activity when determining the overhead application rate.(Use the next page for your answer) (5 marks)

ii.An income statement using variable costing in the contribution margin format. (Use the next page for your answer) (5 marks)

d.Provide the calculations (below) to reconcile the difference between the operating incomes calculated in part (c) (3 marks)

e.State your findings to the controller. It should include a response to her concerns about rising inventory levels and the effect on income. Explain to the controller one way in which these issues be controlled. (2 marks)

QUESTION 4 - (continued)

(c)Absorption costing income statement

(d)Variable costing income statement