ABC, Inc. has been in business 2 years and the president does not understand how in the 2nd year the income would be higher after they sold the same amount of units.
Below are the income statements for the first two years of operations.
	Absorption Costing Income Statement
	Year 1	Year 2
Sales	$640,000	$640,000
Less: Cost of good sold	460,000	420,000
Gross Margin	180,000	220,000
Selling and administrative expenses:
Variable	20,000	20,000
Fixed	70,000	70,000
Net income	90,000	130,000
Below is the production and sales information for the first 2 years:
	Year 1	Year 2
Production in units	20,000	25,000
Sales in units	20,000	20,000
Sales price per unit	$32	$32
Direct material per unit	$7	$7
Direct labor per unit	$4	$4
Variable manufacturing overhead per unit	$2	$2
Variable selling and administrative expense per unit sold	$1	$1
Fixed manufacturing overhead costs(Total)	$200,000	$200,000
Fixed Selling and Administrative costs (Total)	$70,000	$70,000
***ABC, Inc. applies fixed manufacturing overhead costs to its only product on the basis of each year's annual production. Therefore, there is a new fixed manufacturing overhead rate each year.
Required:	Use the information in the DATA field above using cell referencing to answer the following requirements.
1. Calculate the unit production cost for variable costing for year 1 and year 2. Review Exhibit 8-2 on page 320.
2. Calculate the unit production cost for absorption costing for year 1 and year 2. Review Exhibit 8-2 on page 320.
3. Prepare variable-costing income statements for year 1 and year 2. Review Exhibit 8-3 on page 321.
4. Reconcile the differences in income between absorption and variable costing. Use the information I provided in the absorption income statement, the data, and your answers from 1-3 to complete the table below.
I have set up the table using the shortcut reconciliation on page 323.
5. Explain to the President, why there is a difference in the absorption costing income statement from year 1 to year 2 and if the company is actually more profitable.
6. Calculate the breakeven point in units. Reference page 271.
7. Calculate the breakeven point in sales dollars.
8. Prepare a variable costing income statement for this company if they sold at breakeven. How do you know that your breakeven income statement is correct?
9. Calculate the safety margin in dollars. Explain what the margin of safety means in your own words using this project? Reference page 289-290. Be very explicit in your answer, so I know you understand this concept and the importance of it to managers.
10. Calculate the operating leverage factor. Reference page 288.
11. What if sales volume increases by 3% how much will income increase in percentage terms? Make sure you have read over the operating leverage material and
understand the operating leverage factor that impacts the percentage change in net income when there are changes in sales volume.
12. What if the direct labor cost per unit increases from $4 a unit to $5, what will be the new breakeven in units? Explain why it changed.
You should only have to change the direct labor in the data area and all your answers should be updated.
Please put the direct labor cost back to the original number once you have answered the question, since this is a what if question and want the answers for 1-11 to be based on the original data.
13. What if the manufacturing overhead cost decreases from $200,000 to $180,000, what will be the new breakeven in units? Explain why it changed.
You should only have to change the fixed MOH in the data area and actually all your answers should be updated.
Please put the fixed MOH cost back to the original number once you have answered the question, since this is a what if question and want the answers for 1-11 to be based on the original data.
Solution:
1.
Unit production cost for Variable costing	Year 1	Year 2
Total per unit cost
2.
Unit production cost for Absorption Costing	Year 1	Year 2
Total per unit cost
3.	ABC Company Inc.
	Variable Costing Income statement
	Year 1	Year 2
Sales Revenue
Less: Variable Expenses:
Variable manufacturing costs
Variable Selling and administrative costs
Contribution margin
Less: Fixed Expenses:
Fixed manufacturing overhead
Fixed selling and Administrative expenses
Net income
4.
Year	Change in inventory		Predetermined Fixed-Overhead rate		Difference in Fixed Overhead Expensed		Absorption-Costing Income minus Variable-costing income
Year 1		X		=		=
Year 2		X		=		=
5. Explanation to President
The difference in income is caused because of the increase in production in year 2. For external reporting purposes, a company is allowed to defer recognition of FOH until the units are sold under the matching principle.
The company is actually not more profitable in year 2 and if you review the variable costing income statement you will see that net income is the same both years. I would recommend we use
variable costing income statement for internal purposes to monitor the profitability of the company, since variable costing expenses off all fixed overhead.
6.	Break even in units
	Units
7.	Break even in sales $
	Breakeven Income Statement
Sales Revenue
Less: Variable Expenses:
Variable manufacturing costs
Variable Selling and administrative costs
Contribution margin
Less: Fixed Expenses:
Fixed manufacturing overhead
Fixed selling and Administrative expenses
Net income
9. Safety Margin in Dollars				On page 290, I realize the author uses budgeted sales revenue in the margin of safety calculation, but if you are
				given the actual sales revenue you can replace budgeted sales with actual sales, which you should do for #9.
What does the margin of safety mean? Be very explicit in your answer, so I know you understand this concept and the importance of it to managers.
10. Calculate the operating leverage . Reference page 288.
11. What if sales volume increases by 3% how much will income increase in percentage terms? Make sure you have read over the operating leverage material and
understand the operating leverage factor that impacts the percentage change in net income when there are changes in sales volume.
12. What if the direct labor cost per unit increases from $4 a unit to $5, what will be the new breakeven in units? Explain why it changed.
You should only have to change the direct labor in the data area and all your answers should be updated. Please put the direct labor cost back to the original number once you have answered the question?
Please put the direct labor cost back to the original number once you have answered the question, since this is a what if question and want the answers for 1-11 to be based on the original data.
13. What if the manufacturing overhead cost decreases from $200,000 to $180,000, what will be the new breakeven in units? Explain why it changed.
You should only have to change the fixed MOH in the data area and actually all your answers should be updated. Please put the fixed MOH cost back to the original number once you have answered the question?
Please put the fixed MOH cost back to the original number once you have answered the question, since this is a what if question and want the answers for 1-11 to be based on the original data.
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