Question: Effects of differing production levels on absorption costing income: Metrics to minimize inventory buildups. Mountain Press produces textbooks for high school accounting courses. The company recently hired a new editor, Jan Green, to handle production and sales of books for an introductory accounting course. Jan's compensation depends on the gross margin associated with sales of this book. Jan needs to decide how many copies of the books to produce. The following information is available for the fall semester of 2017:
Estimated sales 50,000 books
Beginning inventory 0 books
Average selling price $ 160 per book
Variable production costs $ 100 per book
Fixed production costs $ 750,000 per semester
The fixed-cost allocation rate is based on expected sales and is therefore wqual to $750,000/50,000 books = $15 per book
Jan has decided to produce either 50,000, 65,000, or 70,000 books.
1. Calculate expected gross margin if Jan produces 50,000, 65,000, or 70,000 books. (Make sure you include the production-volume variance as part of cost of goods sold.)
2. Calculate ending inventory in units and in dollars for each production level.
3. Managers who are paid a bonus that is a function of gross margin may be inspired to produce a product in excess of demand to maximize their own bonus. The chapter suggested metrics to discourage managers from producing products in excess of demand. Do you think the following metrics will accomplish this objective? Show your work.
a. Incorporate a charge of 10% of the cost of the ending inventory as an expense for evaluating the manager.
b. Include nonfinancial measures (such as the ones recommended on page 341) when evaluating management and rewarding performance.