Starfax, Inc., manufactures a small part that is widely used in various electronic products such as home computers. Results for the first three years of operations were as follows (absorption costing basis): Sales Cost of goods sold Gross margin Selling and administrative expenses Net operating income (loss) Year 1 $ 819,200 593,920 225,280 194,560 $ 30,720 Year 2 $ 655,360 409,600 245, 760 184,320 $ 61,440 Year 3 $ 819,200 634,880 184,320 174,080 $ 110,2401 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. As a result, Starfax's sales dropped by 20% during Year 2 even though production increased during the year. Management had expected sales to remain constant at 51,200 units; the increased production was designed to provide the company with a buffer of protection against unexpected spurts in demand. By the start of Year 3, management could see that it had excess inventory and that spurts in demand were unlikely. To reduce the excessive inventories, Starfax cut back production during Year 3, as shown below: Year 1 Year 2 Year 3 Production in units 51,200 61,440 40,960 51,200 40,960 51,200 Sales in units 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 $2.00 per unit, and fixed manufacturing overhead expenses total $491,520 per year. b. A new fixed manufacturing overhead rate is computed each year based on that year's actual fixed manufacturing overhead costs divided by the actual number of units produced c. Variable selling and administrative expenses were $1 per unit sold in each year. Fixed selling and administrative expenses totaled $140.960 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 units in Inventory are sold first.) Starfox'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. Req 1 Req 2A Reg 2B Req 5B Prepare a variable costing income statement for each year. Starfax, Inc. Variable Costing Income Statement Year 1 Year 2 Year 3 Variable expenses: Total variable expenses Fixed expenses Total fixed expenses Net operating income (loss) Reconcile the variable costing and absorption costing net operating income figures for each year. (Enter any losses or deductions as a negative value.) Reconciliation of Variable Costing and Absorption Costing Net Operating Incomes Year 1 Year 2 Year 3 Variable costing net operating income (loss) Add fixed manufacturing overhead deferred in inventory Deduct fixed manufacturing overhead cost released from inventory Absorption costing not 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 Year 3
