Starfax, Inc., manufactures a small part that is widely used in various electronic products such as home computers. Operating results for the first three years of activity were as follows (absorption costing basis):

	Year 1		Year 2		Year 3
Sales	$	800,000	$	720,000	$	800,000
Cost of goods sold		640,000		522,000		673,000
Gross margin		160,000		198,000		127,000
Selling and administrative expenses		140,000		132,000		140,000
Net operating income (loss)	$	20,000	$	66,000	$	(13,000)

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. As a result, Starfaxs Sales dropped by 10% during Year 2 even though production increased during the year. Management had expected sales to remain constant at 40,000 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 inventory was excessive 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	40,000	45,000	36,000
Sales in units	40,000	36,000	40,000

Additional information about the company follows:

a.	The companys plant is highly automated. Variable manufacturing expenses (direct materials, direct labor, and variable manufacturing overhead) total only $2.50 per unit, and fixed manufacturing overhead expenses total $540,000 per year.
b.	Fixed manufacturing overhead costs are applied to units of product on the basis of each years production. That is, a new fixed manufacturing overhead rate is computed each year.
c.	Variable selling and administrative expenses were $2 per unit sold in each year. Fixed selling and administrative expenses totaled $60,000 per year.
d.	The company uses a FIFO inventory flow assumption.

Starfaxs management cant understand why profits doubled during Year 2 when sales dropped by 10%, and why a loss was incurred during Year 3 when sales recovered to previous levels.

Required: 1. Prepare a contribution format variable costing income statement for each year Starfax, Inc Variable Costing Income Statement Year 3 Year 1 Year 2 40,000 36,000 40,000 Unit sales 800.000 720,000 800,000 Sales Variable expenses: 0 0 0 Total variable expenses 800,000 800,000 720,000 Fixed expenses: 0 0 0 Total fixed expenses S 800,000 720,000 800,000 Net operating income (loss)