Problem 5-25 Prepare and Interpret Income Statements; Changes inBoth Sales and Production; Lean Production [LO5-1, LO5-2,LO5-3]
Starfax, Inc., manufactures a small part that is widely used invarious electronic products such as home computers. Operatingresults for the first three years of activity were as follows(absorption costing basis):
| Year 1 | Year 2 | Year 3 |
| Sales | $ | 1,000,000 | $ | 800,000 | $ | 1,000,000 |
| Cost of goods sold | | 740,000 | | 520,000 | | 785,000 |
| Gross margin | | 260,000 | | 280,000 | | 215,000 |
| Selling and administrative expenses | | 220,000 | | 190,000 | | 220,000 |
| Net operating income (loss) | $ | 40,000 | $ | 90,000 | $ | (5,000) |
|
In the latter part of Year 2, a competitor went out of businessand in the process dumped a large number of units on the market. Asa result, Starfax’s Sales dropped by 20% during Year 2 even thoughproduction increased during the year. Management had expected salesto remain constant at 50,000 units; the increased production wasdesigned to provide the company with a buffer of protection againstunexpected spurts in demand. By the start of Year 3, managementcould see that inventory was excessive and that spurts in demandwere unlikely. To reduce the excessive inventories, Starfax cutback production during Year 3, as shown below:
| Year 1 | | Year 2 | | Year 3 |
| Production in units | $ | 50,000 | | | $ | 60,000 | | | | 40,000 | |
| Sales in units | | 50,000 | | | | 40,000 | | | | 50,000 | |
|
Additional information about the company follows:
- The company’s plant is highly automated. Variable manufacturingexpenses (direct materials, direct labor, and variablemanufacturing overhead) total only $4.00 per unit, and fixedmanufacturing overhead expenses total $540,000 peryear.
- Fixed manufacturing overhead costs are applied to units ofproduct on the basis of each year’s production. That is, a newfixed manufacturing overhead rate is computed each year.
- Variable selling and administrative expenses were $3 per unitsold in each year. Fixed selling and administrative expensestotaled $70,000 per year.
- The company uses a FIFO inventory flow assumption.
Starfax’s management can’t understand why profits more thandoubled during Year 2 when sales dropped by 20%, and why a loss wasincurred during Year 3 when sales recovered to previous levels.
Required:
1. Prepare a contribution format variable costing incomestatement for each year.
2a. Compute the unit product cost in each year under absorptioncosting. (Round your answers to 2 decimalplaces.)
2b. Reconcile the variable costing and absorption costing netoperating income (loss) figures for each year.
5b. If Lean Production had been used during Year 2 and Year 3and the predetermined overhead rate is based on 50,000 units peryear, what would the company's net operating income (loss) havebeen in each year under absorption costing? (Losses shouldbe indicated by a minus sign.)
