Ways to reduce this incentive include a careful

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period’s cost of goods sold.Ways to reduce this incentive include(a)Careful budgeting and inventory planning.(b)Change the accounting system to variable costing or throughput costing.(c)Incorporate a carrying charge for carrying inventory.(d)Use a longer time period to evaluate performance than a quarter or a year.(e) Include nonfinancial as well as financial measures when evaluating managementperformance.9-31(10–20 min.)Breakeven under absorption costing (chapter appendix). Refer toProblem 9-30.1.The unit contribution margin is $5 – $3 – $1 = $1. Total fixed costs ($540,000) dividedby the unit contribution margin ($1.00) equals 540,000 units. Therefore, under variable costing540,000 units must be soldto break even.2.If there are no changes in inventory levels, the breakeven point can be the same, 540,000units, under both variable costing and absorption costing. However, as the chapter demonstrates,under absorption costing, the breakeven point is not unique; operating income is a function ofboth sales and production. Some fixed overhead is “held back” when inventories rise (10,000units × $0.70 = $7,000), so operating income is positive even though sales are at the breakevenlevel as commonly conceived.=()TargetFixed manuf.BreakevenTotal fixedUnitsoperatingoverheadsales incostsproducedincomerateunitsUnit contribution margin� �� �� �� �Let N=Breakeven sales in unitsN =00.1$)000550N(70.0$0$000540$N=$0.30N=$155,000N=516,667 units (rounded)Therefore, under absorption costing, when 550,000 units are produced, 516,667 unitsmust be sold for the income statement to report zero operating income.Proof of 2007 breakeven point:Gross margin, 516,667 units × ($5.00 – $3.70)$671,667Output level MOH variance, as before$ 35,000Marketing and administrative costs:9-29
Variable, 516,667 units × $1.00516,667Fixed120,000671,667Operating income$ 03.If no units are sold, variable costing will show an operating loss equal to the fixedmanufacturing costs, $420,000 in this instance. In contrast, the company would break even underabsorption costing, although nothing was sold to customers. This is an extreme example of whathas been called “selling fixed manufacturing overhead to inventory.”A final note: We find it helpful to place the following comparisons on the board, keyed to thethree parts of this problem:1. Variable costing: Breakeven = f (sales)2. Absorption costing: Breakeven = f (sales and production)3.Zero units sold: Breakeven = f (0 units sold and 540,000 units produced), anextreme case9-32(40 min.)Variable costing and absorption costing, the All-Fixed Company.This problem always generates active classroom discussion. 1.The treatment of fixed manufacturing overhead in absorption costing is affected primarilyby what denominator level is selected as a base for allocating fixed manufacturing costs to unitsproduced. In this case, is 10,000 tons per year, 20,000 tons, or some other denominator level themost appropriate base?We usually place the following possibilities on the board or overhead projector and thenask the students to indicate by vote how many used one denominator level versus another.

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