Variable Costing for Management Analysis LO 2 – Using Income Analysis

Frand Manufacturing Company LO 2 Frand Manufacturing Company FRAND Frand Manufacturing Company has no beginning inventory, and sales are estimated to be 20,000 units at $75 per unit, regardless of production levels. The management of Frand Manufacturing Company is evaluating whether to manufacture 20,000 units (Proposal 1) or 25,000 units (Proposal 2). Frand Manufacturing Company has no beginning inventory. It estimates sales to be 20,000 units at $75 per unit, regardless of production levels.

LO 2 Proposal 1 FRAND When 20,000 units are manufactured and sold, total manufacturing costs equal $1,100,000, and total selling and administrative expenses equal $200,000.

LO 2 Proposal 2 FRAND When 25,000 units are manufactured and only 20,000 units are sold, total manufacturing costs equal $1,275,000, and total selling and administrative expenses equal $200,000.

Income Analysis Under Absorption and Variable Costing LO 2 Income Analysis Under Absorption and Variable Costing FRAND $35V 20F $55 When absorption costing is used, the level of units manufactured affects the unit cost. Fixed costs per unit decline when the number of units manufactured increases. When 20,000 units are manufactured, fixed costs equal $20 ($400,000/20,000) per unit, and total unit cost is $55 per unit.

Income Analysis Under Absorption and Variable Costing LO 2 Income Analysis Under Absorption and Variable Costing FRAND $35V 16F $51 When absorption costing is used, the level of units manufactured affects the unit cost because fixed costs per unit decline as the number of units manufactured increases. When 25,000 units are manufactured, fixed costs drop $4 per unit to $16 ($400,000/25,000), and total unit cost drops to $51 per unit.

Income Analysis Under Absorption and Variable Costing LO 2 Income Analysis Under Absorption and Variable Costing FRAND Income from operations is $80,000 higher when 25,000 units are manufactured because the cost of goods sold dropped by $80,000. This results because 25,000 units were manufactured, 20,000 units were sold, and 5,000 units remained in inventory at a cost of $225,000. Because the fixed manufacturing cost per unit drops from $20 to $16, total manufacturing cost per unit drops from $55 to $51. Since the cost per unit is $4 less for the 20,000 units sold, income from operations increases $80,000.

Frand Manufacturing Company LO 2 Frand Manufacturing Company FRAND Now, assume that Frand Manufacturing uses variable costing and has sales of 20,000 units. Exhibit 6 illustrates that net income remains a constant $200,000 at three levels of production. If Frand Manufacturing uses variable costing and has sales of 20,000, the income remains constant at any level of production.

Income Analysis Under Absorption and Variable Costing LO 2 Income Analysis Under Absorption and Variable Costing FRAND Income from operations equals $200,000 under all three levels of production. Fixed manufacturing costs are not included in per-unit cost; they are expensed in the period incurred. Therefore, the level of production does not impact the cost of goods sold. Many accountants believe that absorption costing distorts profit margins and recommend using variable costing.