As a continuing assignment with Albatross Packaging Corporation, you have been asked to provide additional assistance in developing an information system to improve the company's costing data... With the growth in the company over the past several years, the corporate management believes that the company needs to improve its accounting information system by adding variable costing and other appropriate methods to aid in short term decision making. One of the most important changes needed in a new accounting information system will be to training the accounting staff. None have had much experience with modern management accounting techniques.
Sales fluctuate seasonally. Inventory builds up in anticipation of the next sales cycle in not uncommon. However, after factoring out such seasonal fluctuations, inventory has grown steadily considerable over the past five years. The CEO is concerned that the company's financial statements are not presenting a true picture of the health of the company. Therefore, he would like to implement a variable costing system for internal decision making, but he is uncertain how to proceed and whether the advantages of the system will outweigh the costs of implementation. He has asked you for advice.
He has provided the following information related to the past two years.
Production capacity is 20,600,000 units. The following information concerns annual sales and manufacturing and period costs.
The past two years' sales and production
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Year 1
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year 2
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Sales
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14,500,000
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14,500,000
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Beg FG
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850,000
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1,200,000
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End FG
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1,200,000
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1,500,000
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Production
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14,850,000
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14,800,000
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Budgeted unit manufacturing costs:
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Variable costs
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Direct materials
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0.18
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Direct labor
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0.30
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Variable overhead
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0.15
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Selling variable
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0.07
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Total variable costs
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0.70
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Fixed costs (manufacturing and selling/administration
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Manufacturing
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4,000,000
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Selling
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1,750,000
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Administrative
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3,250,000
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Sales price per unit is $1.50. Assume beginning inventory for year 1 has the same per unit value as that calculated in year 1.
Required:
1. Prepare absorption costing income statements and variable costing income statements for the previous two years using the above information. Be sure to set up the data in a spreadsheet that will be useful for what-if analysis (see 2 below).
2. To illustrate the impact of inventory increases and decreases on income on the bottom line, assume that the following are the new inventory balances for the years 1995 and 1996: (two separate spreadsheet analysis required)
a. Rapidly Rising inventories
Year 1 Year 2
Beginning FG inventory 850,000 units 1,450,000 units
Ending FG inventory 1,450,000 units 2,300,000 units
Production ? ? ,
b. Rapidly Rising inventories
Year 1 Year 2
Beginning FG inventory 850,000 units 2,750,000 units
Ending FG inventory 2,750,000 units 6,850,000 units
Production ? ? ,
c. Declining inventories
Year 1 Year 2
Beginning FG inventory 850,000 units 400,000 units
Ending FG inventory 400,000 units 5,000 units
Production ? ?
3. As part of the consulting assignment, the company CEO asks that you prepare some basic what-if analyses for the coming year using CVP. Use year 1 (1a) financial data for all analysis unless otherwise stated. Work from the variable income statement.
Required: Assume each part is independent of the others in your analysis.
a. Calculate the breakeven point for the Company in units and in sales dollars.
b. Compute the margin of safety in units and in dollars.
c. If the company wishes to earn an after-tax income of $3,000,000, what is the break even in units? Assume that the corporate income tax rate is 40%.
d. The Company is considering the use of less expensive materials in the production. If this cost can be reduced by $0.05 per unit, what impact will this change have on net income?
e. Assume that in order to achieve the reduction of $0.05 in direct material costs, the company will need to invest an additional $500,000 annually in fixed manufacturing costs by purchasing new equipment. What is the impact on the operating income for the year? Should the company invest in the new equipment?
f. In a brief report, discuss with the CEO the advantage of the variable costing format for internal decision making. Use the information from the analysis to illustrate your discussion points. Also address the break even analysis that you performed and make recommendations where appropriate.