Question: Variable and absorption costing, sales, and operating-income changes. Candyland uses standard costing to produce a particularly popular type of candy. Candyland's president, Jack McCay, was unhappy after reviewing the income statements for the first three years of business. He said, "I was told by our accountants-and in fact, I have memorized-that our breakeven volume is 25,000 units. I was happy that we reached that sales goal in each of our first two years. But here's the strange thing: In our first year, we sold 25,000 units and indeed we broke even. Then in our second year we sold the same volume and had a significant, positive operating income. I didn't complain, of course ... but here's the bad part. In our third year, we sold 10% more candy, but our operating income dropped by nearly 90% from what it was in the second year! We didn't change our selling price or cost structure over the past three years and have no price, efficiency, or spending variances so what's going on?!"
1. What denominator level is Candyland using to allocate fixed manufacturing costs to the candy? How is Candyland disposing of any favorable or unfavorable production-volume variance at the end of the year? Explain your answer briefly.
2. How did Candyland's accountants arrive at the breakeven volume of 25,000 units?
3. Prepare a variable costing-based income statement for each year. Explain the variation in variable costing operating income for each year based on contribution margin per unit and sales volume.
4. Reconcile the operating incomes under variable costing and absorption costing for each year, and use this information to explain to Jack McCay the positive operating income in 2017 and the drop in operating income in 2018.