Starfax, Incorporated, 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 Year 1 $ 812,800 589,280 223,520 193,040 Year 2 $ 650,240 406,400 Year 3 $ 812,800 629,920 243,840 182,880 182,880 172,720 $ 30,480 $ 60,960 $ \10,160\ Net operating income (loss) 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 50,800 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: Production in units Sales in units Year 1 50,800 50,800 Year 2 60,960 40,640 Year 3 40,640 50,800