Question

The annual data that follow pertain to Sea Down There, a manufacturer of swimming goggles (the company had no beginning inventory):Sales Price $ 49Variable Manufacturing expense per unit $22Sales commission expense per unit $ 11Fixed Manufacturing overhead $2,760,000Fixed operating expenses $245,000Number of goggles produced $ 230,000Number of goggles sold $ 215,000(1) Prepare both conventional (absorption costing) and contribution margin (variable costing) income statements for Sea Down There for the year.(2) Which statement shows the higher operating income? Why?(3) The company marketing vice president believes a new sales promotion that costs $ 150,000 would increase sales to 230,000 goggles. Should the company go ahead with the promotion? Give your reason.

Answer 1

Answer:

1.  SEA DOWN    

INCOME STATEMENT      

               conventional  Variable

sales         10535000  10535000  

cost of sales  -7310000               - 4730000  

commission                    - 2365000  

contribution                      3440000  

gross profit  3225000    

commission  -2365000    

fixed costs                      - 2760000  

operating costs -245000             -245000  

net income  615000              435000  

2. Absorption method has the higher operating income, because manufacturing costs are charged to the cost of units and are usually less costly per unit ( the more units produced the lesser fixed costs become) than in total and in Variable method fixed costs are taken as a total.

3.              conventional  Variable  

sales          11270000  11270000

cost of sales  -7820000  -5060000

commission                     -2530000

contribution                     3680000

gross profit  3450000  

commission  -2530000  

fixed costs                        - 2760000

marketing cost -150000               -150000

operating costs -245000               -245000

net income  525000               525000

If the company is using Absorption method as basis for decision then it should not take the promotion as it yields to a decrease in net income. If the company uses Variable method as basis then it should take the promotion as it leads to an increase in profits.

Overall I think the company should take the promotion because it has an increased contribution to fixed costs and the two methods yield the same net income and that is a guarantee.

Explanation:

                  units  

opening           0  

produced  230000  

closing        - 15000  

sold                 215000  

  unit cost

 Arbsoption Variable

VC             22 22

FIXED      12  

UNIT COST     34 22