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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		750,000		540,000		787,500
Gross margin		250,000		260,000		212,500
Selling and administrativeexpenses		230,000		200,000		230,000
Net operating income (loss)	$	20,000	$	60,000	$	(17,500)

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:

	Year1				Year2				Year3
Production inunits	$	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 $6.00 per unit, and fixedmanufacturing overhead expenses total $450,000 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 $80,000 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.

	Starfax, Inc., Variable Costing Income Statement Year 1 Year 2 Year 3 Unit sales 50,000 40,000 50,000 Variable expenses: Total variable expenses Fixed expenses: Total fixed expenses Net operating income (loss)

2a. Compute the unit product cost in each year under absorptioncosting. (Round your answers to 2 decimalplaces.)

	Year 1 Year 2 Year 3 Unit product cost

2b. Reconcile the variable costing and absorption costing netoperating income (loss) figures for each year.

Reconciliation of Variable Costing and Absorption Costing NetOperating Incomes (Losses) Year 1 Year 2 Year 3 Variable costing net operating income (loss) Add (Deduct) fixed manufacturing overhead cost deferred in(released from) Year 2 and released in year 3 Add (Deduct) fixed manufacturing overhead cost deferred in(released from) Year 3 and released in future under absorptioncosting Absorption costing net operating income (loss)

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.)

	Year 1 Net operating income (loss) Year 2 Net operating income (loss) Year 3 Net operating income (loss)