Ch 6 Answers
Ferguson Products Inc., a manufacturer, reported $130 million in sales and a loss of $25 million in its absorption costing income statement provided to shareholders. According to a CVP analysis prepared for management, the company’s break-even point is $120 million in sales. |
Required: | Assuming that the CVP analysis is correct, is it likely that the company’s inventory level increased, decreased, or remained unchanged during the year? | | Decreased |
Explanation: Sales were above the company’s break-even sales and yet the company sustained a loss. The apparent contradiction is explained by the fact that the CVP analysis is based on variable costing, whereas the income reported to shareholders is prepared using absorption costing. Because sales were above the breakeven, the variable costing net operating income would have been positive. However, the absorption costing net operating income was negative. Ordinarily, this would only happen if inventories decreased and fixed manufacturing overhead deferred in inventories was released to the income statement on the absorption costing income statement. This added fixed manufacturing overhead cost resulted in a loss on an absorption costing basis even though the company operated at its breakeven on a variable costing basis. | Amcor, Inc., incurs the following costs to produce and sell a single product. |
| | | Variable costs per unit: | | | Direct materials | | $ 10 | Direct labor | | $ 5 | Variable manufacturing overhead | | $ 2 | Variable selling and administrative expenses | | $ 4 | Fixed costs per year: | | | Fixed manufacturing overhead | $ 90,000 | Fixed selling and administrative expenses | $ 300,000 | |
During the last year, 30,000 units were produced and 25,000 units were sold. The Finished Goods inventory account at the end of the year shows a balance of $85,000 for the 5,000 unsold units. |
Required: | Assuming that the CVP analysis is correct, is it likely that the company’s inventory level increased, decreased, or remained unchanged during the year? | | Decreased |
Explanation: Sales were above the company’s break-even sales and yet the company sustained a loss. The apparent contradiction is explained by the fact that the CVP analysis is based on variable costing, whereas the income reported to shareholders is prepared using absorption costing. Because sales were above the breakeven, the variable costing net operating income would have been positive. However, the absorption costing net operating income was negative. Ordinarily, this would only happen if inventories decreased and fixed manufacturing overhead deferred in inventories was released to the income statement on the absorption costing income statement. This added fixed manufacturing overhead cost resulted in a loss on an absorption costing basis even though the company operated at its breakeven on a variable costing basis. | Amcor, Inc., incurs the following costs to produce and sell a single product. |
| | | Variable costs per unit: | | | Direct materials | | $ 10 | Direct labor | | $ 5 | Variable manufacturing overhead | | $ 2 | Variable selling and administrative expenses | | $ 4 | Fixed costs per year: | | | Fixed manufacturing overhead | $ 90,000 | Fixed selling and administrative expenses | $ 300,000 | |
During the last year, 30,000 units were produced and 25,000 units were sold. The Finished Goods inventory account at the end of the year shows a balance of $85,000 for the 5,000 unsold units. |