The demand for solvent, one of numerous products manufactured by RZM Industries Inc., has dropped sharply because of recent competition from a similar product. The company's chemists are currently completing tests of various new formulas, and it is anticipated that the manufacture of a superior product can be started on June 1, one month in the future. No changes will be needed in the present production facilities to manufacture the new product because only the mixture of the various materials will be changed.
The controller has been asked by the president of the company for advice on whether to continue production during May or to suspend the manufacture of solvent until June 1. The controller has assembled the following pertinent data:
RZM Industries Inc.
Income Statement-Solvent
For the Month Ended April 30
Sales (4,000 units) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $500,000
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 424,000
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 76,000
Selling and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102,000
Loss from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (26,000)
The production costs and selling and administrative expenses, based on production of 4,000 units in April, are as follows:
Direct materials ..................................................... $45 per unit
Direct labor ......................................................... 20 per unit
Variable manufacturing cost ...................................... 16 per unit
Variable selling and administrative expenses ................... 15 per unit
Fixed manufacturing cost ..........................................$100,000 for April
Fixed selling and administrative expenses ....................... 42,000 for April
Sales for May are expected to drop about 20% below those of the preceding month. No significant changes are anticipated in the fixed costs or variable costs per unit. No extra costs will be incurred in discontinuing operations in the portion of the plant associated with solvent. The inventory of solvent at the beginning and end of May is expected to be inconsequential.
Instructions
1. Prepare an estimated income statement in absorption costing form for May for solvent, assuming that production continues during the month.
2. Prepare an estimated income statement in variable costing form for May for solvent, assuming that production continues during the month.
3. What would be the estimated loss in income from operations if the solvent production were temporarily suspended for May?
4. What advice should the controller give to management?