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Required:: CASE 6-19 The Case of The Plummeting Profits Lean Production

The controller at a company saw a drop in net operating income for the second quarter due to using absorption costing. Absorption costing relies on both production and sales levels, and producing fewer units in the second quarter meant fixed costs were not fully absorbed. Preparing variable costing income statements showed higher net operating income for the second quarter compared to absorption costing. The reconciliation of the two methods showed absorption costing deferred some overhead costs to inventory that variable costing expensed immediately. Introducing lean production in the second quarter, with zero ending inventory, would result in 8,000 units produced to meet the quarter's sales. Starting in the third quarter, there would be little difference between absorption and variable

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121 views3 pages

Required:: CASE 6-19 The Case of The Plummeting Profits Lean Production

The controller at a company saw a drop in net operating income for the second quarter due to using absorption costing. Absorption costing relies on both production and sales levels, and producing fewer units in the second quarter meant fixed costs were not fully absorbed. Preparing variable costing income statements showed higher net operating income for the second quarter compared to absorption costing. The reconciliation of the two methods showed absorption costing deferred some overhead costs to inventory that variable costing expensed immediately. Introducing lean production in the second quarter, with zero ending inventory, would result in 8,000 units produced to meet the quarter's sales. Starting in the third quarter, there would be little difference between absorption and variable

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ricky setiawan
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© © All Rights Reserved
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Kathleen Herber

CASE 6–19 The Case of the Plummeting Profits; Lean Production

Required:

1. What characteristic of absorption costing caused the drop in net operating income for the second
quarter and what could the controller have said to explain the problem?

With absorption costing the net operating income relies on both production and sales so he was
correct in his explanation, however he could have maybe explained better how since they had an
under applied amount of overhead from their reduction in produced items and that by producing less
that they were not able to absorb all of the fixed manufacturing costs into units of production. That is
why you see this drop in net operating income for the second quarter.

2. Prepare a contribution format variable costing income statement for each quarter.

First Second
Quarter Quarter

Sales $480,000 $600,000


Variable Expenses:
Variable cost of good sold 96000 120000
Variable selling and administrative
expense 60000 75000
Total Variable Expense 156000 195000

Contribution margin $324,000 $405,000

Fixed Expenses:
Fixed manufacturing overhead $180,000 $180,000
Fixed selling and administrative
expense 140,000 140,000
Total fixed expense $320,000 $320,000

Net operating income (loss) $4,000 $85,000

Selling and administrative


expenses 200,000
Less variable portion 60,000
(12,000 units x $5.00 per unit)
Total Fixed selling and administrative expenses 140,000

3. Reconcile the absorption costing and the variable costing net operating income figures for each
quarter.

Reconciliation of Absorption costing and the Variable Costing Net income figures
First Quarter Second Quarter
Variable costing net operating income $4,000 $85,000
Deduct: Fixed manufacturing overhead cost released from
inventory during the First Quarter (4,000 units × $12 per
unit) -48000
Add (deduct): Fixed manufacturing overhead cost deferred
in inventory from the First Quarter to the Second Quarter
(7,000 units × $12 per unit) 84000 -84000
Add: Fixed manufacturing overhead cost deferred in
inventory from the Second Quarter to the future (1,000
units × $12 per unit) 12000
Absorption costing net operating income $40,000 $13,000

4. Identify and discuss the advantages and disadvantages of using the variable costing method for
internal reporting purposes.

There are several advantages to using the variable costing method:

~Make is easier to estimate the profitability of products.

~Profit is unchanged by changes in inventories.

~Profit and sales move in the same direction.

Some of the disadvantages using the variable costing method:

~Not able to use as an external report, you may run the risk of an auditor not excepting the
financial statement.

~It may be difficult to determine what are fixed costs as apposed to variable costs.

5. Assume that the company had introduced Lean Production at the beginning of the second quarter,
resulting in zero ending inventory. (Sales and production during the first quarter remain the same.)

How many units would have been produced during the second quarter under Lean Production?
a.
If we utilized the JIT Production theory, producing only enough units to meet the demands of
sales the equation would be as follows:

Units Sold……………………………………………. 15,000

Less units in Inventory at the beg of qtr..………… 7,000

Units produced in second qtr. for JIT……………… 8,000


b. Starting with the third quarter, would you expect any difference between the net operating
income reported under absorption costing and under variable costing? Explain why there would
or would not be any difference.

Starting with the third quarter there would be little or no difference between the net operating
income reported under absorption costing and variable costing because there would be a lack of
inventories. This would make it impossible to incorporate the fixed manufacturing overhead cost
between the periods.

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