Problem:
Ystad Industries: Roland Anderson is the manager of the Ekland Division of Ystad Industries. He is one of several managers being considered for position of CEO, as the current CEO is retiring in a year.
All divisions use standard absorption costing. The division has the capacity to produce 50,000 units a quarter and quarterly fixed overhead amounts to $500,000. Variable production cost is $45 per unit. Roland has been looking at the report for the first three months of the year and is not happy with the results.
Ekland Division: Income Statement
For the Quarter Ending March 31, 2012
Production: 25,000 units
Sales (25,000 units)
- $2,500,000
Cost of goods sold
Beginning inventory (10,000 units)
- $650,000
Production costs applied
- 1,625,000
Total = $2,275,000
Less ending inventory
650,000
1,625,000
Gross profit
875,000
Selling & general expenses
500,000
Net income
$375,000
The sales forecast for the second quarter is 25,000 units. Roland had budgeted second quarter production at 25,000 units but changes it to 50,000 units, which is total capacity for a quarter. The sales forecasts for each of the last two quarters of the year are also 25,000 units. Costs incurred in the second quarter are the same as budgeted, based on 50,000 units of production.
Required: Computations
Convert the Ekland absorption income statement to a contribution margin income statement for the first quarter. Prepare absorption and contribution margin income statements for the second quarter for Ekland. Compute production costs per unit for both approaches and for both years.
Discussion:
- Did Roland improve his performance for the second quarter? Indicate the information you used for your assessment.
- Can you make any suggestions for reporting in the future?
- Do you think Roland should be seriously considered for the CEO position? Why or why not?
- Discuss three shortcomings of the absorption approach for internal decision-making.