Question 2 (25 Marks) Part A: Stars, Inc. is a manufacturing company that has made toys for children for three years. The CEO Mr. Jones is very ustlated with the company's performance and has hired Mr. Kaye as the company's new accountant. Mr. Jones provides the following information to Mr. Kaye. Year 1 Year 2 Year 3 Sales in units 60,000 40,000 40,000 Production in units 60,000 50,000 60,000 Price $ 10 10 10 The company's variable manufacturing cost (including direct materials, direct labor, and variable manufacturing overhead) is $5 per unit. Fixed manufacturing overhead is $120,000 per year. The variable selling and administrative expense is $1 per unit and the xed selling and administrative expense is $100,000 per year. The company uses the LIFO (last-in rst-out) inventory ow assumption that the newest units in inventory are sold rst. After reviewing all information provided, Mr. Kaye prepared one income statement for Mr. Jones, with the purpose of discovering the existing problems within the company and gathering information for future decision making. Required: a. Prepare the same income statement Mr. Kaye has provided for Mr. Jones. (5 marks) b. Mr. Jones realizes that there are two types of income statements and each gives different values for Net Operating Income. Please show how to reconcile the differences in Net Operating Income between the two income statements. (5 marks) c. After reviewing all the information provided, Mr. Kaye also raised some concerns with the numbers from the income statement he has prepared for Mr. Jones. Explain his concerns. (5 marks) Part B: Which type of income statements, Contribution Format or Traditional Format should be used to identify relevant costs? Please provide explanation for your answer. Then provide an example including two income statements based on absorption and variable costing, respectively, to support your explanation. (5 marks) Part C: Mr. Jones also considers improving the production efciency of his company. He realizes if he rents a new equipment, the production costs will be reduced. He then gathers the following information: The new equipment can be rented at a cost of $60,000 a year. To operate the new equipment, the company also needs to hire a supervisor whose annual salary is $40,000. The equipment will reduce the direct materials cost and direct labor cost by 50%. Currently, direct materials, director labor, and variable manufacturing overhead cost $2, $2, and $1, respectively. Mr. Jones further finds that the use of new equipment has no impact on the company's fixed manufacturing overhead. REE ed: Mr. Jones is not sure whether it is worthwhile to rent the new equipment. Mr. Kaye shows his prediction of the next three years' sales. In Year 4, Year 5, and Year 6, the predicted sales units are 40,000, 50,000, and 60,000, respectively. Please make your recommendations to Mr. Jones, in which year should the company rent the new equipment? (5 marks) 3
