Saxon, Inc.

Absorption Costing Income Statement

For the Year Ended December $31$

Sales $$1,280,000$

Cost of goods sold:

Cost of goods manufactured $$840,000$

Ending inventory $(168,000)$

Total cost of goods sold $(672,000)$

Gross profit $$608,000$

Selling and administrative expenses $(273,000)$

Operating income $$335,000$

Variable Statement

Under variable costing, the cost of goods manufactured includes only variable manufacturing costs. This type of income statement includes a computation of manufacturing margin.

Saxon, Inc.

Variable Costing Income Statement

For the Year Ended December $31$

Sales $$1,280,000$

Variable cost of goods sold:

Variable cost of goods manufactured $$600,000$

Ending inventory $(120,000)$

Total variable cost of goods sold $(480,000)$

Manufacturing margin $$800,000$

Variable selling and administrative expenses $(208,000)$

Contribution margin $$592,000$

Fixed costs:

Fixed manufacturing costs $$240,000$

Fixed selling and administrative expenses $65,000$

Total fixed costs $(305,000)$

Operating income $$287,000$

Method Comparison

Review the income statements on the Absorption Statement and Variable Statement, then complete the following table. The company$$s sales price per unit is $$80,$ and the number of units in ending inventory is $4,000.$ There was no beginning inventory.

Item Amount

Number of units sold fill in the blank $2$a$0$e$47082$ff$4027\_1$

Variable sales and administrative cost per unit $fill in the blank $2$a$0$e$47082$ff$4027\_2$

Number of units manufactured fill in the blank $2$a$0$e$47082$ff$4027\_3$

Variable cost of goods manufactured per unit $fill in the blank $2$a$0$e$47082$ff$4027\_4$

Fixed manufacturing cost per unit $fill in the blank $2$a$0$e$47082$ff$4027\_5$

Question Content Area

Manufacturing Decisions

Whenever the units manufactured differ from the units sold, finished goods inventory is affected. In analyzing operating income, such increases and decreases could be misinterpreted as operating efficiencies or inefficiencies. Each decision$-$making situation should be carefully analyzed in deciding whether absorption or variable costing reporting would be more useful.

All costs are controllable in the long run by someone within a business. For a given level of management, costs may be controllable costs or noncontrollable costs.

The production manager for Saxon, Inc. is worried because the company is not showing a high enough profit. Looking at the income statements on the Absorption Statement and the Variable Statement, he notices that the operating income is higher on the absorption cost income statement. He is considering manufacturing another $10,000$ units, up to the company$$s capacity for manufacturing, in the coming year. He reasons that this will boost operating income and satisfy the company$$s owner that the company is sufficiently profitable. Although the total units manufactured changes, assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same. Complete questions $(1)-(4)$ that follow. If the answer is zero, enter $"0".$

$1.$ Use the income statements on the Absorption Statement and Variable Statement to complete the following table for the original production level. Then prepare similar income statements at a production level $10,000$ units higher and add that information to the table. Assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same at both production levels.

Operating Income

Original Production

Level$-$Absorption Original Production

Level$-$Variable Additional $10,000$

Units$-$Absorption Additional $10,000$

Units$-$Variable

$fill in the blank $2$f$91$b$603102$bf$9$d$\_1$

$fill in the blank $2$f$91$b$603102$bf$9$d$\_2$

$fill in the blank $2$f$91$b$603102$bf$9$d$\_3$

$fill in the blank $2$f$91$b$603102$bf$9$d$\_4$

$2.$ What is the change in operating income from producing $10,000$ additional units under absorption costing?

$fill in the blank $2$f$91$b$603102$bf$9$d$\_5$

$3.$ What is the change in operating income from producing $10,000$ additional units under variable costing?

$fill in the blank $2$f$91$b$603102$bf$9$d$\_6$

$4.$ What would be your recommendation to the production manager?

a$.$ Do not produce the extra $10,000$ units. The increase in operating income under absorption costing is due to fixed manufacturing costs being held in inventory, and the additional inventory will lead to higher handling, storage, financing, and obsolescence costs.

b$.$ Produce the extra $10,000$ units. Operating income will be increased, and the production manager will receive praise for creating higher profits.

c$.$ Do not produce the extra $10,000$ units. Operating income does not change under absorption costing when the additional units are produced.

d$.$ Produce the extra $10,000$ units. It's always a good idea to have extra units on hand and keep the factory operating at capacity, even if all the units are not sold.