Do not produce the extra 10,000 units. The increase in operating income under absorption costing is due to fixed manufacturing costs being held in inventory, and the additional inventory will lead to higher handling, storage, financing, and obsolescence costs.
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Whenever the units manufactured differ from the units sold, finished goods inventory is affected. In analyzing operating income, such increases and decreases could be misinterpreted as operating efficiencies or inefficiencies. Each decision-making situation should be carefully analyzed in deciding whether absorption or variable costing reporting would be more useful.
All costs are controllable in the long run by someone within a business. For a given level of management, costs may be controllable costs or noncontrollable costs.
The production manager for Saxon, Inc. is worried because the company is not showing a high enough profit. Looking at the income statements on the Absorption Statement and the Variable Statement, he notices that the operating income is higher on the absorption cost income statement. He is considering manufacturing another 10,000 units, up to the company’s capacity for manufacturing, in the coming year. He reasons that this will boost operating income and satisfy the company’s owner that the company is sufficiently profitable. Although the total units manufactured changes, assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same. Complete questions (1)-(4) that follow. If the answer is zero, enter "0".
1. Use the income statements on the Absorption Statement and Variable Statement to complete the following table for the original production level. Then prepare similar income statements at a production level 10,000 units higher and add that information to the table. Assume that total fixed costs, unit variable costs, unit sales price, and the sales levels are the same at both production levels.
Operating Income Original Production
Level-AbsorptionOriginal Production
Level-VariableAdditional 10,000
Units-AbsorptionAdditional 10,000
Units-Variable$fill in the blank 73eb91f57f9e06b_1 $fill in the blank 73eb91f57f9e06b_2 $fill in the blank 73eb91f57f9e06b_3 $fill in the blank 73eb91f57f9e06b_4 2. What is the change in operating income from producing 10,000 additional units under absorption costing?
$fill in the blank 73eb91f57f9e06b_5
3. What is the change in operating income from producing 10,000 additional units under variable costing?
$fill in the blank 73eb91f57f9e06b_6
4. What would be your recommendation to the production manager?
a. Do not produce the extra 10,000 units. The increase in operating income under absorption costing is due to fixed
manufacturing costs being held in inventory, and the additional inventory will lead to higher handling, storage, financing, and obsolescence costs.b. Produce the extra 10,000 units. Operating income will be increased, and the production manager will receive praise for creating higher profits.
c. Do not produce the extra 10,000 units. Operating income does not change under absorption costing when the additional units are produced.
d. Produce the extra 10,000 units. It's always a good idea to have extra units on hand and keep the factory operating at capacity, even if all the units are not sold.
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