Chapter 7, Problem 18P

To determine

Answer 1:

Breakeven point is that level of sales at which the Company is at a No profit no loss situation. This means that the company is able to fully recover its variable cost and fixed cost but nothing above that.

Breakeven point in Unit Sales

Answer to Problem 18P

Solution:

Break-even Point (Unit Sales) = 60,000 units

Explanation of Solution

1. Break-even point is computed to calculate the minimum sales that must be achieved to arrive at a no profit no loss situation;
2. Break-even point in unit salesis calculated by dividing the Fixed cost with contribution per unit
Break-even point in dollar salesis calculated by dividing the Fixed cost with contribution Margin %
3. Contribution per unit is Selling price per unit less variable cost per unit.

• Given: Selling Price and Variable cost per unit is readily given
• Formula used:

  $\text{Break-even Point (Unit Sales) = }\frac{\text{Fixed Cost}}{\text{(Selling price per unit - Variable Cost per unit)}}$

• Calculation:

$\begin{array}{l}\text{Fixed Cost = Fixed Manufacturing Overhead + Fixed Selling and Administrative Expenses}\\ \text{Fixed Cost = \$ 960,000 + \$ 240,000 = \$ 1,200,000}\end{array}$

Selling Price per unit = $ 58 per unit

$\begin{array}{l}\text{Variable Cost per unit = Direct material + Direct labour + Variable Manufacturing Overhead }\\ \text{+ Variable Selling \& Admin Overhead}\end{array}$

$\text{Variable Cost per unit = \$ 20 + \$ 12 + \$ 4 + \$ 2 = \$ 38 per unit}$

  $\text{Break-even Point (Unit Sales) = }\frac{\text{\$ 1,200,000}}{\text{(\$ 58 per unit - \$ 38 per unit)}}$ = 60,000 units

Conclusion

Haas Company will have to sell atleast 60,000 units to be able to fully recover its variable as well as fixed cost.

Answer 2

Variable Costing: is also known as Direct costing method. In this method, those costs which vary directly with production are considered in product cost. Fixed Manufacturing Expenses are treated as period cost and not product cost. Selling Expenses (since they do not vary with production), both variable and fixed, are charged off completely in the period in which the expenses get incurred.

To determine

Unit product Cost and Income statement for 3 years under variable costing

Answer to Problem 18P

Solution:

Explanation of Solution

1. In variable costing, direct material, direct labour and variable manufacturing expenses are considered for unit product cost;
2. The income statement under this method requires following computations:

  $\begin{array}{l}\text{Sales - Variable Cost = Contribution}\\ \text{Contribution - Fixed Cost = Net Operating Income}\end{array}$

Variable cost comprises of variable cost of goods sold and variable selling expenses

Fixed cost comprises of fixed manufacturing cost and fixed selling cost

• Formulas:

Variable Cost of Goods Sold:

  $\begin{array}{l}\text{Beginning Inventory Quantity X Unit Product Cost of previous period + }\\ \text{Current Production Quantity X Unit Product cost of current period -}\\ \text{Closing Inventory Quantity X Unit Product Cost of current period}\end{array}$

  $\text{Variable Selling \& Admin Expenses = Sales Quantity X Variable Selling Expenses per unit}$

  $\text{Contribution Margin = Sales Value - (Cost of Goods Sold + variable Selling Expenses)}$

Note: Unit product cost here is unit cost computed as per variable costing.

Answer 3

Absorption Costing: is also known as Full costing method. In this method, those costs which vary directly with production are considered in product cost. Also, fixed Manufacturing Expenses are treated as product cost only. Selling Expenses (since they do not vary with production), both variable and fixed, are charged off completely in the period in which the expenses get incurred.

To determine

Unit product Cost and Income statement for 3 years under absorption costing.

Answer to Problem 18P

Solution:

Computation of Unit Product Cost under Absorption Costing
	Year 1	Year 2	Year 3
Direct Material	$ 20	$ 20	$ 20
Direct Labour	$ 12	$ 12	$ 12
Variable Manufacturing Overhead	$ 4	$ 4	$ 4
Fixed Manufacturing Overhead	$ 16	$ 13	$ 24
Total Product Cost	$ 52	$ 49	$ 60

Income Statement under Absorption Costing
		Year 1	Year 2	Year 3
A	Sales(Sales Volume X Sales Price)	$3,480,000	$2,900,000	$3,770,000
B	Less: Cost of Goods Sold
C	Beginning Inventory (Opening Inventory Quantity X Unit Product Cost of previous year)			$1,220,000
D	Add: Cost of Goods Manufactured (Production Quantity X Unit Product Cost)	$3,120,000	$3,660,000	$2,400,000
E	Less: Closing Inventory (Closing Inventory Quantity X Unit Product Cost of current year)	$ -	$1,220,000	$ -
B	Cost of Goods Sold (C+D-E)	$3,120,000	$2,440,000	$3,620,000
F	Gross Margin (A - B)	$ 360,000	$ 460,000	$ 150,000
G	Variable Selling & Admin Expenses (Sales quantity X Variable selling cost per unit)	$ 120,000	$ 100,000	$ 130,000
H	Fixed Selling Overhead	$ 240,000	$ 240,000	$ 240,000
I	Net Operating Income (F - G - H)	$ -	$ 120,000	$ (220,000)

Working Note:

	Year 1	Year 2	Year 3	Remarks
Sales Volume	60,000	50,000	65,000	(as given in question)
Production Volume	60,000	75,000	40,000	(as given in question)
Opening Stock	-	-	25,000	(Closing Stock of previous year)
Closing Stock	-	25,000	-	(Opening Stock + Production - Sales)
Selling Price per unit	58	58	58	(as given in question)
Variable Manufacturing Cost per unit	$52	$49	$60	(Computed Unit Product Cost)
Fixed Manufacturing Cost	$960,000	$960,000	$960,000
Fixed Manufacturing Cost per unit	$16	$13	$24	(Fixed manufacturing cost / Production Qty)
Variable Selling Cost	$2	$2	$2	(as given in question)

Explanation of Solution

1. In absorption costing, direct material, direct labour, variable manufacturing expenses and fixed manufacturing cost per unit are considered for unit product cost;
2. The income statement under this method requires following computations:

  $\begin{array}{l}\text{Sales - Cost of Goods Sold = Gross Margin}\\ \text{Gross Margin - Total Selling Cost = Net Operating Income}\end{array}$

Cost of Goods Sold comprises of variable as well as fixed manufacturing cost

Total selling expenses comprise of variable as well as fixed selling cost

• Formulas:

Cost of Goods Sold:

$\begin{array}{l}\text{Beginning Inventory Quantity X Variable Production Cost of previous period + }\\ \text{Current Production Quantity X Variable Production cost of current period -}\\ \text{Closing Inventory Quantity X Variable Production Cost of current period}\end{array}$

  $\text{Variable Selling \& Admin Expenses = Sales Quantity X Variable Selling Expenses per unit}$

  $\text{Fixed Manufacturing Cost per unit = }\frac{\text{Fixed manufacturing cost of a period}}{\text{Production Quantity of the same period}}$

Note: Unit product cost here is unit cost computed as per absorption costing.

Answer 4

To determine

1. Comparison of operating income under variable costing

Explanation of Solution

	Year 1	Year 2	Year 3
Break Even Unit in Sales	60,000	60,000	60,000
Actual Sales Quantity	60,000	50,000	65,000
Net Operating Income	$ -	$(200,000)	$ 100,000

Break-even point, actual sales quantity and net operating income have been taken from computations above.

Conclusion:

In Year 1, Actual sales are equal to Break-even which means No profit No Loss situation.

In Year 2, Actual sales are less than Break-even. As such, there is loss under this costing system

border-bottom: solid 1px black;>In Year 3, Actual sales are more than Break-even. As such, there is profit under this costing system

To determine

Comparison of operating income under absorption costing

Explanation of Solution

Comparison under Absorption Costing
	Year 1	Year 2	Year 3
Break Even Unit in Sales	60,000	60,000	60,000
Actual Sales Quantity	60,000	50,000	65,000
Net Operating Income	$ -	$ 120,000	$(220,000)

Break-even point, actual sales quantity and net operating income have been taken from computations above.

Conclusion:In Year 1, Actual sales are equal to Break-even which means No profit No Loss situation.In Year 2, Actual sales are less than Break-even. However, still there is profit under this costing systemIn Year 3, Actual sales are more than Break-even. However, still there is loss under this costing

Net operating income under Absorption Costing seem counter intuitive. This is because the Full Fixed Manufacturing Cost are not expensed in the same year but are deferred to the extent of closing stock quantity.