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Unformatted text preview: able to sell only 200,000 of the bulbs produced and if the productionvolume variance is closed to cost of goods sold, then the operating income is given as in requirement 3 of 937. 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. In this example, setting the denominator to equal the master budget (the lowest of the four capacity levels here), minimizes the loss to the manager from being unable to sell the entire production quantity of 220,000 bulbs. 941 3. In this scenario, the manager of ELF produces 220,000 bulbs and sells 200,000 of them, and the production volume variance is prorated. Given the absence of ending work in process inventory or beginning inventory of any kind, the fraction of the production volume variance that is absorbed into the cost of goods sold is given by 200,000/220,000 or 10/11. The operating income under various denominator levels is then given by the following modification of the solution to requirement 3 of 937: Theoretical Practical Normal Master Budget Revenue $1,800,000 $1,800,000 $1,800,000 $1,800,000 Less: Cost of goods sold 750,000 900,000 1,300,000 1,500,000 Prorated production volume variance a 659,091 U 509,091 U 109,091 U (90,909 ) F Gross margin 390,909 390,909 390,909 390,909 Variable selling b 50,000 50,000 50,000 50,000 Fixed selling 250,000 250,000 250,000 250,000 Operating income $ 90,909 $ 90,909 $ 90,909 $ 90,909 a (10/11) × 725,000, × 560,000, × 120,000, × 100,000 b 200,000 × 0.25 Under the proration approach, operating income is $90,909 regardless of the denominator initially used. Thus, in contrast to the case where the production volume variance is written off to cost of goods sold, there is no temptation under the proration approach for the manager to play games with the choice of denominator level. 942 939 (30 min.) Cost allocation, downward demand spiral. SOLUTION EXHIBIT 939 2009 Master Budget (1) Practical Capacity (2) 2010 Master Budget (3) Budgeted fixed costs $1,533,00 $1,533,00 $1,533,00 Denominator level 1,022,000 1,460,000 876,000 Budgeted fixed cost per meal Budgeted fixed costs ÷ Denominator level ($1,533,000 ÷ 1,022,000; $1,533,000 ÷ 1,460,000; $1,533,000 ÷ 876,000) $ 1.50 $ 1.05 $ 1.75 Budgeted variable cost per meal 4.5 4.5 4.5 Total budgeted cost per meal $ 6.0 $ 5.5 5 $ 6.2 5 1. The 2009 budgeted fixed costs are $1,533,000. Deliman budgets for 1,022,000 meals in 2009, and this is used as the denominator level to calculate the fixed cost per meal. $1,533,000 ÷ 1,022,000 = $1.50 fixed cost per meal. (see column (1) in Solution Exhibit 939)....
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 Fall '10
 ALANSTYLES
 Income Statement, gross margin

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