Joan Hill, President of Hill & Hill Pens, was lookingforward to receiving the company’s second quarter income statement.She knew that the sales budget of 20,000 units sold had been metduring the second quarter and that this was an increase of 25% overthe first quarter sales units (16,000 units in Q1). She was happyabout the increase in sales, since Hill & Hill Pens was aboutto approach its bank for additional loan money for expansionpurposes. She anticipated the strong second-quarter results wouldbe a real plus in persuading the bank to extend the additionalcredit.
For this reason, Joan was shocked when she saw the first twoquarters income statement below. Instead of increasing operatingincome, there was a decrease.
Hill & Hill Pens Income Statements For the First Two Quarters |
| First Quarter | Second Quarter |
Sales | | $1,600,000 | | $2,000,000 |
-COGS | | | | |
Beg Inv | $ 210,000 | | 490,000 | |
COGM | 1,400,000 | | 980,000 | |
-End Inv | <490,000> | | < 70,000> | |
+/- Adj for PVV | 0 | | 240,000 | |
| | 1,120,000 | | 1,640,000 |
= Gross margin | | $ 480,000 | | $ 360,000 |
-Selling & Admin | | | | |
Variable | | 80,000 | | 100,000 |
Fixed | | 230,000 | | 230,000 |
Operating Income | | $ 170,000 | | $ 30,000 |
Joan was certain there had to be an error somewhere andimmediately called the controller into her office to find theproblem. The controller stated, “The operating income is correct,Joan. Sales went up during the second quarter, but the problem isin production. You see, we budgeted to produce 20,000 units eachquarter, but a strike in one of our supplier’s plants forced us tocut production back to only 14,000 units in the second quarter.That’s what caused the drop in operating income.”
Joan replied, “I don’t understand this! I know sales increased,yet you talk about production to explain the drop in income! Whatdoes this have to do with the sales that we made? If sales go up,then income ought to go up.”
Budgeted production and sales for the year, along with actualproduction and sales for the first two quarters are givenbelow:
| 1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter |
Planned (budgeted) sales | 16,000 | 20,000 | 20,000 | 24,000 |
Actual sales | 16,000 | 20,000 | | |
| | | | |
Planned (budgeted) production | 20,000 | 20,000 | 20,000 | 20,000 |
Actual production | 20,000 | 14,000 | - | - |
The company’s plant is heavily automated, so fixed manufacturingoverhead costs total $800,000 per quarter. Variable manufacturingcosts are $30 per unit. The fixed manufacturing overhead cost isapplied to units at the rate of $40 per unit (based on the budgetedproduction shown above ? $800,000/20,000 units = $40 per unit). AnyProduction Volume Variance is closed directly to COGS for thequarter.
The company had 3,000 units in inventory at the start of thefirst quarter. Variable selling and administrative expenses are $5per unit.
Required:
- Prepare a variable cost (contribution format) income statementfor the first two quarters. (worth 40%)
- Explain why the operating incomes are different. (worth20%)
- Explain why the first quarter has a $ 0Production Volume Variance (PVV) and the second quarter has a$240,000 PVV. Why is the $240,000 PVV added toCOGS? (worth 20%)
- Given that you may need to consult with owners of small-sizedbusiness in the future, what are some of the advantages anddisadvantages of preparing a variable costing method incomestatement for them? (worth 20%)
