Smart Safety, a three-year-old company, has been producing and selling a single type of bicycle helmet. Smart Safety uses standard costing. After reviewing the income statements for the first three years, Stuart Weil, president of Smart Safety, commented, "I was told by our accountantsand in fact, I have memorizedthat our breakeven volume is 49,000 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 49,000 units and indeed we broke even. Then, in our second year we sold the same volume and had a positive operating income. I didn't complain, of course. .. but here's the bad part. In our third year, we sold 20% more helmets, but our operating income fell by more than 80% relative to the second year! We didn't change our selling price or cost structure over the past three years and have no price, efficiency, or rate variances ... so what's going on?!" Absorption Costing 2011 2012 2013 Sales (units) 49,000 49,000 58,800 $ 1,960,000 $ 1,960,000 $ 2,352,000 Revenues Cost of goods sold: Beginning inventory 0 0 352,800 1,764,000 2,116,800 1,764,000 Production Available for sale 1,764,000 2,116,800 2,116,800 Deduct ending inventory 0 (352,800) 0 0 (215,600) 0 Adjustment for production-volume variance 1,764,000 1,548,400 2,116,800 Cost of goods sold Gross margin 196,000 411,600 235,200 Selling and administrative expenses (all fixed) 196,000 196,000 196,000 $ 0 $ 215,600 39,200 Operating income Beginning inventory 0 0 9,800 Production (units) 49,000 58,800 49,000 Sales (units) 49,000 49,000 58,800 Ending inventory 0 9,800 0 Variable manufacturing cost per unit $ 14 $ 14 $ 14 Fixed manufacturing overhead costs $ 1,078,000 $ 1,078,000 $ 1,078,000 Fixed manuf. costs allocated per unit produced 22 $ 22 $ 22 1. What denominator level is Smart Safety using to allocate fixed manufacturing costs to the bicycle helmets? How is Smart Safety disposing of any favourable or unfavourable production-volume variance at the end of the year? Explain your answer briefly. 2. How did Smart Safety's accountants arrive at the breakeven volume of 49,000 units? 3. Prepare a variable-costing-based income statement for each year. Explain the variation in 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 Stuart Weil the positive operating income in 2012 and the drop in operating income in 2013