Sun Company, a subsidiary of Guardian, Inc., produces and sells three product lines. The company employs a standard cost accounting system for record keeping purposes. At the beginning of the current year, the president of Sun Company presented the budget to the parent company and accepted a commitment to contribute $15,800 to Guardian’s consolidated profit for the year. The president has been confident that the year’s profit would exceed the budget target, since the monthly sales reports that he has been receiving have shown that sales for the year will exceed budget by 10%. The president is both disturbed and confused when the controller presents an adjusted forecast as of November 30 indicating that profit will be 11% under budget. The two forecasts are presented below: Sun Company Forecasts of Operating Results 1/1 11/30 Sales $268,000 $294,800 Cost of goods sold at standard* 212,000 233,200 Gross margin at standard $ 56,000 $ 61,600 Over- (under-) absorbed fixed manufacturing overhead -- (6,000) Actual gross margin $ 56,000 $ 55,600 Selling expenses $ 13,400 $ 14,740 Administrative expenses 26,800 26,800 Total operating expenses $ 40,200 $ 41,540 Earnings before taxes $ 15,800 $ 14,060 *Includes fixed manufacturing overhead of $30,000.
Sun Company, a subsidiary of Guardian, Inc., produces and sells three product lines. The company employs a
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Sun Company |
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Forecasts of Operating Results |
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1/1 |
11/30 |
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Sales |
$268,000 |
$294,800 |
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Cost of goods sold at standard* |
212,000 |
233,200 |
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Gross margin at standard |
$ 56,000 |
$ 61,600 |
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Over- (under-) absorbed fixed manufacturing overhead |
-- |
(6,000) |
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Actual gross margin |
$ 56,000 |
$ 55,600 |
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Selling expenses |
$ 13,400 |
$ 14,740 |
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Administrative expenses |
26,800 |
26,800 |
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Total operating expenses |
$ 40,200 |
$ 41,540 |
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Earnings before taxes |
$ 15,800 |
$ 14,060 |
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*Includes fixed manufacturing overhead of $30,000. |
There have been no sales price changes or product mix shifts since the 1/1 forecast. The only cost variance on the income statement is the underabsorbed manufacturing overhead. This arose because the company produced only 16,000 standard machine hours (budgeted machine hours were 20,000) during the year as a result of a shortage of raw materials while its supplier was closed by a strike. Fortunately, Sun Company’s finished goods inventory was large enough to fill all sales orders received.
- Analyze and explain why the profit has declined in spite of increased sales and good control over costs.
- What plan, if any, could Sun Company adopt during December to improve their reported profit at year end? Explain your answer.
- To avoid the confusing effect of the present procedure, illustrate how Sun Company could adopt variable (direct) costing.
- Would the alternative procedure described in Question 3 be acceptable to Guardian, Inc., for financial reporting purposes? Explain.
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