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Seems likely that demand is going to fall below 6000

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seems likely that demand is going to fall below 6,000, it may be better to shut down its production capacity and outsource all of its needed units. This may also allow the management to examine and pursue other business options, as its current business gets increasingly competitive. 9-39
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9-37 (35 min.) Absorption costing and production volume variance -- alternative capacity bases 1. Inventoriable cost per unit = Variable production cost + Fixed manufacturing overhead/Capacity Capacity Type Capacity Level Fixed Mfg. Overhead Fixed Mfg. Overhead Rate Variable Production Cost Inventoriable Cost Per Unit Theoretical 800,000 $1,000,000 $1.25 $2.50 $3.75 Practical 500,000 $1,000,000 $2.00 $2.50 $4.50 Normal 250,000 $1,000,000 $4.00 $2.50 $6.50 Master Budget 200,000 $1,000,000 $5.00 $2.50 $7.50 2. ELF’s actual production level is 220,000 bulbs. We can compute the production-volume variance as: Production Volume Variance = Budgeted Fixed Mfg. Overhead – (Fixed Mfg. Overhead Rate × Actual Production Level) Capacity Type Capacity Level Fixed Mfg. Overhead Fixed Mfg. Overhead Rate Fixed Mfg. Overhead Rate × Actual Production Production Volume Variance Theoretical 800,000 $1,000,000 $1.25 $ 275,000 $725,000 U Practical 500,000 $1,000,000 $2.00 $ 440,000 $560,000 U Normal 250,000 $1,000,000 $4.00 $ 880,000 $120,000 U Master Budget 200,000 $1,000,000 $5.00 $1,100,000 $100,000 F 3. Operating Income for ELF given production of 220,000 bulbs and sales of 200,000 bulbs @ $9 apiece: Theoretical Practical Normal Master Budget Revenue $1,800,000 $1,800,000 $1,800,000 $1,800,000 Less: Cost of goods sold a 750,000 900,000 1,300,000 1,500,000 Production- volume variance 725,000 U 560,000 U 120,000 U (100,000 )F Gross margin 325,000 340,000 380,000 400,000 Variable selling b 50,000 50,000 50,000 50,000 Fixed selling 250,000 250,000 250,000 250,000 Operating income $ 25,000 $ 40,000 $ 80,000 $ 100,000 a 200,000 × 3.75, × 4.50, × 6.50, × 7.50 b 200,000 × 0.25 9-40
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9.38 (35 min.) Operating income effects of denominator-level choice and disposal of production-volume variance (continuation of 9-37) 1. Since no beginning inventories exist, if ELF sells all 220,000 bulbs manufactured, its operating income will be the same under all four capacity options. Calculations are provided below: Theoretical Practical Normal Master Budget Revenue $1,980,000 $1,980,000 $1,980,000 $1,980,000 Less: Cost of goods sold a 825,000 990,000 1,430,000 1,650,000 Production volume variance 725,000 U 560,000 U 120,000 U (100,000 ) F Gross margin 430,000 430,000 430,000 430,000 Variable selling b 55,000 55,000 55,000 55,000 Fixed selling 250,000 250,000 250,000 250,000 Operating income $ 125,000 $ 125,000 $ 125,000 $ 125,000 a 220,000 × 3.75, × 4.50, × 6.50, × 7.50 b 200,000 × 0.25 2. If the manager of ELF produces and sells 220,000 bulbs, then all capacity levels will result in the same operating income of $125,000 (see requirement 1 above). If the manager of ELF is able to sell only 200,000 of the bulbs produced and if the production-volume variance is closed to cost of goods sold, then the operating income is given as in requirement 3 of 9-37. Both sets of numbers are reproduced below. Theoretical Practical Normal Master Budget Income with sales of 220,000 bulbs $125,000 $125,000 $125,000 $125,000 Income with sales of 200,000 bulbs 25,000 40,000 80,000 100,000 Decrease in income when there is over production $100,000 $ 85,000 $ 45,000 $ 25,000 Comparing these results, it is clear that for a given level of overproduction relative to sales, the manager’s performance will appear better if he/she uses as the denominator a level that is lower.
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