Chapter 7, Problem 2PB

Income statements under absorption costing and variable costing

The demand for aloe vera hand lotion, one of numerous products manufactured by Smooth Skin Care Products Inc., has dropped sharply because of recent competition from a similar product. The company’s chemists are currently completing tests of various new formulas, and it is anticipated that the manufacture of a superior product can be started on December 1, one month in the future. No changes will be needed in the present production facilities to manufacture the new product because only the mixture of the various materials will be changed.

The controller has been asked by the president of the company for advice on whether to continue production during November or to suspend the manufacture of aloe vera hand lotion until December 1. The controller has assembled the following pertinent data:

The production costs and selling and administrative expenses, based on production of 400,000 units in October, are as follows:

Sales for November are expected to drop about 20% below those of the preceding month. No significant changes are anticipated in the fixed costs or variable costs per unit. No extra costs will be incurred in discontinuing operations in the portion of the plant associated with aloe vera hand lotion. The inventory of aloe vera hand lotion at the beginning and end of November is expected to be inconsequential.

Instructions

1. 1. Prepare an estimated income statement in absorption costing form for November for aloe vera hand lotion, assuming that production continues during the month.
2. 2. Prepare an estimated income statement in variable costing form for November for aloe vera hand lotion, assuming that production continues during the month.
3. 3. What would be the estimated operating loss if the aloe vera hand lotion production were temporarily suspended for November?
4. 4. What advice should the controller give to management?