Question

QUESTION 4 Pandalela Ltd. manufactures high performance swimming goggles in Bomeo. The firm uses an absorption costing system for internal reporting purposes. However, the newly appointed chief management accountant, is highly considering using variable costing. The following data pertain to the firm's operation from 2014 to 2016. 2014 2015 2016 Production and inventory data: Finished-goods inventory (in units), January 1 Actual production (in units) Sales (in units) -0- 50,000 50,000 -0- 50,000 35,000 15,000 50,000 65,000 RM 48 Revenue and cost data, all three years: Sales price per unit Manufacturing costs per unit: Direct material Direct labor Variable manufacturing overhead RM12 RM8 RM4 Budgeted fixed manufacturing overhead is RM12 per unit per year. Variable selling and administration amount to RM4 per goggle. Fixed selling and administration amount cost is RM100,000 per year. The top management has called for a meeting for all managers in one week's time. The new chief management accountant was given the following questions in advance and is asked to provide the answers at the planned meeting. Required: a. Prepare operating income statements for Pandalela Ltd. for its first three years of operations using: i Absorption costing ii. Variable costing (15 marks) b. Explain which statement, absorption or variable costing that managers would prefer and why (by providing an example relating sales and income)? (3 marks) c. When inventory increases, will absorption costing or variable costing income be greater? Why? (3 marks) d. Explain which is more consistent with cost-volume profit analysis, variable or absorption costing and why? (4 marks) TOTAL: 25 MARKS

Answer 1

Q4)
a) Operating incomes:
i: ABSORPTION COSTING:
YEAR	2014	2015	2016
Units sold	50000	35000	65000
Units produced	50000	50000	50000
Sales @ 48	2400000	1680000	3120000
Less:Manufacturing costs:
Direct Mat.	600000	420000	780000
Direct Lab.	400000	280000	520000
Variable Manuf. OH	200000	140000	260000
Fixed Manuf. OH	600000	600000	600000
Less/Add:FMOH portion of CS	0	-180000	180000	(15000*12)
Total Manufacturing costs	1800000	1260000	2340000
Gross Profit	600000	420000	780000
Less:Selling and Admin costs:
Variable	200000	140000	260000
Fixed	100000	100000	100000
Total Selling and Admin costs	300000	240000	360000
Net Operating Income	300000	180000	420000
ii: VARIABLE COSTING:
YEAR	2014	2015	2016
Units sold	50000	35000	65000
Units produced	50000	50000	50000
Sales @ 48	2400000	1680000	3120000
Less:Variable costs:
Direct Mat.	600000	420000	780000
Direct Lab.	400000	280000	520000
Variable Manuf. OH	200000	140000	260000
Variable Selling and Admin	200000	140000	260000
Total Variable costs	1400000	980000	1820000
Contribution margin	1000000	700000	1300000
Less:Fixed costs:
Manufacturing	600000	600000	600000
Selling and Admin	100000	100000	100000
Total Selling and Admin costs	700000	700000	700000
Net Operating Income	300000	0	600000
b) Managers would prefer the Absorption costing as costs concerning
the sales are charged and the income is uniformly distributed.
c) When inventory increases, the absorption costing would show a
greater income because it carried forward the fixed manufacturing
overhead of increased inventory to the next year.
d) The variable costing is more consistent with CVP analysis as it
shows constant profit with the sales volume and consider all fixed
costs in the year of production.