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Sales Cost of goods sold Gross margin Selling and administrative expenses Net operating income (loss) Year 1 $1,000,000 740,000 260,000 230,000 $ 30,000 Year 2

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Sales Cost of goods sold Gross margin Selling and administrative expenses Net operating income (loss) Year 1 $1,000,000 740,000 260,000 230,000 $ 30,000 Year 2 $ 780,000 520,000 260,000 200,000 $ 60,000 Year 3 $1,000,000 785,000 215,000 230,000 $ (15,000) In the latter part of Year 2, a competitor went out of business and in the process dumped a large number of units on the market. result, Starfax's sales dropped by 20% during Year 2 even though production increased during the year. Management had expec sales to remain constant at 50,000 units; the increased production was designed to provide the company with a buffer of protect against unexpected spurts in demand. By the start of Year 3, management could see that it had excess inventory and that spurts demand were unlikely. To reduce the excessive inventories, Starfax cut back production during Year 3, as shown below: Production in units Sales in units Year 1 50,000 50,000 Year 2 60.000 60,000 40,000 Year 3 40.000 50,000 Additional information about the company follows: a. The company's plant is highly automated. Variable manufacturing expenses (direct materials, direct labor, and variable manufacturing overhead) total only $4.00 per unit, and fixed manufacturing overhead expenses total $540,000 per year. b. A new fixed manufacturing overhead rate is computed each year based that year's actual fixed manufacturing overhead costs divided by the actual number of units produced. c. Variable selling and administrative expenses were $3 per unit sold in each year. Fixed selling and administrative expenses totale $80,000 per year. d. The company uses a FIFO inventory flow assumption (FIFO means first in first-Out In other words, it assumes that the oldest unit: inventory are sold first.) Starfax's management can't understand why profits doubled during Year 2 when sales dropped by 20% and why a loss was incurred during Year 3 when sales recovered to previous levels. Reg 1 A Reg 2A Reg 28 Reg 5B Reconcile the variable costing and absorption costing net operating income figures for each year. (Enter any losses or deductions as a negative value.) Year 2 Years Reconciliation of Variable Costing and Absorption Costing Net Operating Income Yeart Variable costing net operating income (loss) Add faced manufacturing overhead deferred in inventory Deduct faced manufacturing overhead cost released from inventory Absorption costing net operating income (loss) If Lean Production had been used during Year 2 and Year 3, what would the company's net operating Income (or loss) have been in each year under absorption costing? Year 1 Year 2 Your 3

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