Praline Yum uses standard costing to produce a particularly popular type of candy. Praline Yum's President, John Macon was unhappy after reviewing the income statements for the first three years of business. He said, "I was told by our accountantsand in fact, I have memorizedthat our breakeven volume is 31,000 units. I was happy that we reached that sales goal in each of our first two years. But, here's the strange thing: In our first year, we sold 31,000 units and indeed we broke even. Then, in our second year we sold the same volume and had a signficant, positive operating income. I didn't complain, of course... but here's the bad part. In our third year, we sold 10% more candy, but our operating income dropped by nearly 90% from what it was in the second year! We didn't change our selling price or cost structure over the past three years and have no price, efficiency, or spending variances ... so what's going on?!" Absorption Costing 2016 2017 2018 31,000 31,000 34,100 Sales (units) () Revenues $ 2.418.000 $ 2,418,000 $ 2.659.800 Cost of goods sold Beginning inventory o 0 220,100 Production 2.201.000 2.421,100 2,201.000 Available for sale 2,201,000 2,421,100 2.421,100 Deduct ending inventory (220,100) 0 Adjustment for production volume variance (182,900) 0 Cost of goods sold 2.201.000 2,018, 100 2.421.100 Gross margin 217,000 399,900 238,700 Selling and administrative expenses (all fixed) 217.000 217,000 217,000 $ 0$ 182,900 Operating income 21,700 Beginning inventory 0 3.100 Production (units) 31,000 34,100 31.000 Sales (units) 31,000 31,000 34,100 Ending inventory 0 3.100 0 Variable manufacturing cost per unit 12 $ 12 $ 12 Fored manufacturing overhead costs $! 1.829,000 $ 1,829,000 $ 1.829.000 Fbced manut. costs allocated per unit produced $ 59 $ 59 $ 1. What denominator level is Praline Yum using to allocate fixed manufacturing costs to the candy? How is Praline Yum disposing of any favorable or unfavorable production-volume variance at the end of the year? Explain your answer briefly. 2. How did Praline Yum's accountants arrive at the breakeven volume of 31,000 units? 3. Prepare a variable costing-based income statement for each year. Explain the variation in the variable costing operating income for each year based on contribution margin per unit and sales volume. 4. Reconcile the operating incomes under variable costing and absorption costing for each year, and use this information to explain to John Macon the positive operating income in 2017 and the drop in operating income in 2018. Requirement 1. What denominator level is Praline Yum using to allocate fixed manufacturing costs to the candy? How is Praline Yum disposing of any favorable or unfavorable production-volume variance at the end of the year? Explain your answer briefly. The denominator level used to allocate fixed manufacturing costs is 31,000 units. In 2017, 100 units were We can see from Praline Yum's income statements that it disposes of any production-volume variance against cost of goods sold. produced instead of the budgeted 31,000 units. This resulted in a favorable production-volume variance; which, when written off, increased gross margin. Requirement 2. How did Praline Yum's accountants arrive at the breakeven volume of 31,000 units? Total fixed costs Contribution margin per unit = Breakeven quantity 2016 = 2017 = 2018