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9 31 30 min effects of differing production levels on

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9-31 (30 min.) Effects of differing production levels on absorption costing income: Metrics to minimize inventory buildups. 1. 10,000 books 12,000 books 16,000 books Revenues $1,000,000 $1,000,000 $1,000,000 Cost of goods sold 720,000 a 720,000 720,000 Production-volume variance 0 b ( 24,000 ) c (72,000 ) d Net cost of goods sold 720,000 696,000 648,000 Gross Margin $ 280,000 $ 304,000 $ 352,000 a cost per unit = ($60 + $120,000/10,000 books) = $72 per book CGS = $72 × 10,000 = $720,000 b volume variance = Budgeted fixed cost – fixed overhead rate × production $120,000 – $12 × 10,000 books = $0 c volume variance = Budgeted fixed cost – fixed overhead rate × production $120,000 – $12 × 12,000 books = $24,000 d volume variance = Budgeted fixed cost – fixed overhead rate × production $120,000 – $12 × 16,000 books = $72,000 9-31
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2. 10,000 books 12,000 books 16,000 books Beginning inventory 0 0 0 + Production 10,000 books 12,000 books 16,000 books 10,000 12,000 16,000 ─ Books sold 10,000 10,000 10,000 Ending inventory 0 books 2,000 books 6,000 books × Cost per book × $72 × $72 × $72 Cost of Ending Inventory $0 $144,000 $432,000 3a. 10,000 books 12,000 books 16,000 books Gross margin $280,000 $304,000 $352,000 Less 10% × Ending inventory 0 (14,400 ) (43,200 ) Adjusted gross margin $280,000 $2 89,6 00 $30 8,8 00 While adjusting for ending inventory does to some degree mitigate the increase in inventory associated with excess production, it may be difficult to mechanically compensate for all of the increased income. In addition, it does nothing to hold the manager responsible for the poor decisions from the organization’s standpoint. 3b. 10,000 books 12,000 books 16,000 books 1) Inventory change: End inventory ─ begin inventory 0 2,000 books 6,000 books 2) Excess production (%) Production ÷ sales 10000 ÷ 10,000 12000 ÷ 10000 16000 ÷10000 1.0 1.2 1.6 A ratio of ending inventory to beginning inventory, as suggested in the book, is not possible since beginning inventory was 0, so we substituted change in inventory level. For these non-financial measures to be useful they must be incorporated into the reward function of the manager. 9-32
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9-32 (25–30 min.) Alternative denominator-level capacity concepts, effect on operating income. 1. Budgeted Fixed Budgeted Fixed Days of Hours of Budgeted Manufacturing Denominator-Level Capacity Concept Manuf. Overhead per Period Production per Period Production per Day Barrels per Hour Denominator Level (Barrels) Overhead Rate per Barrel (1) (2) (3) (4) (5) = (2) × (3) × (4) (6) = (1) ÷ (5) Theoretical capacity $28,000,000 360 24 540 4,665,600 $ 6.00 Practical capacity 28,000,000 350 20 500 3,500,000 8.00 Normal capacity utilization 28,000,000 350 20 400 2,800,000 10.00 Master-budget utilization (a) January-June 2009 14,000,000 175 20 320 1,120,000 12.50 (b) July-December 2009 14,000,000 175 20 480 1,680,000 8.33 The differences arise for several reasons: a. The theoretical and practical capacity concepts emphasize supply factors, while normal capacity utilization and master-budget utilization emphasize demand factors. b. The two separate six-month rates for the master-budget utilization concept differ because of seasonal differences in budgeted production. 2. Using column (6) from above, Per Barrel Denominator-Level Capacity Concept Budgeted Fixed Mfg. Overhead Rate per Barrel (6) Budgeted Variable Mfg.
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