Stars, Inc. is a manufacturing company that has made toys for children for three years. The CEO Mr. Jones is very frustrated with the company’s performance and has hired Mr. Kaye as the company’s new accountant. Mr. Jones provides the following information to Mr. Kaye. Year 1 Year 2 Year 3 Sales in units 60,000 40,000 40,000 Production in units 60,000 50,000 60,000 Price $ 10 10 10
Stars, Inc. is a manufacturing company that has made toys for children for three years. The CEO Mr. Jones is
very frustrated with the company’s performance and has hired Mr. Kaye as the company’s new accountant. Mr.
Jones provides the following information to Mr. Kaye.
Year 1 Year 2 Year 3
Sales in units 60,000 40,000 40,000
Production in units 60,000 50,000 60,000
Price $ 10 10 10
The company’s variable
administrative expense is $1 per unit and the fixed selling and administrative expense is $100,000 per year. The
company uses the LIFO (last-in first-out) inventory flow assumption that the newest units in inventory are sold
first.
After reviewing all information provided, Mr. Kaye prepared one income statement for Mr. Jones, with the
purpose of discovering the existing problems within the company and gathering information for future decision
making.
question
1. Mr. Jones realizes that there are two types of income statements and each gives different values for Net
Operating Income. Please show how to reconcile the differences in Net Operating Income between the two
income statements.
2.After reviewing all the information provided, Mr. Kaye also raised some concerns with the numbers
from the income statement he has prepared for Mr. Jones. Explain his concerns
3.Which type of income statements, Contribution Format or Traditional Format should be used to identify relevant
costs? Please provide explanation for your answer. Then provide an example including two income statements
based on absorption and variable costing, respectively, to support your explanation.
4. Mr. Jones also considers improving the production efficiency of his company. He realizes if he rents a new
equipment, the production costs will be reduced. He then gathers the following information:
The new equipment can be rented at a cost of $60,000 a year. To operate the new equipment, the company also
needs to hire a supervisor whose annual salary is $40,000. The equipment will reduce the direct materials cost
and direct labor cost by 50%. Currently, direct materials, director labor, and variable manufacturing overhead
cost $2, $2, and $1, respectively. Mr. Jones further finds that the use of new equipment has no impact on the
company’s fixed manufacturing overhead.
Required:
Mr. Jones is not sure whether it is worthwhile to rent the new equipment. Mr. Kaye shows his prediction of the
next three years’ sales. In Year 4, Year 5, and Year 6, the predicted sales units are 40,000, 50,000, and 60,000,
respectively.
Please make your recommendations to Mr. Jones, in which year should the company rent the new
equipment?
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