Absorption Costing's Effect on Earnings When Volumes Fluctuate

question 4

Essay

Absorption Costing's Effect on Earnings when Volumes Fluctuate
BBG Corporation is a manufacturer of a synthetic chemical.Gary Voss,president of the company,has been eager to get the operating results for the just-completed fiscal year.He was surprised when the income statement revealed that income before taxes had dropped to $885,500 from $900,000,even though sales volume had increased by 100,000 kilograms.The drop in net income occurred even though Voss had implemented two changes during the past 12 months to improve the company's profitability:
1.In response to a 10 percent increase in production costs,the sales price of the company's product was increased by 12 percent.This action took place on December 1,1994,the first day of the current fiscal year.
2.The managers of the selling and administrative departments were given strict instructions to spend no more in the current fiscal year than last year.
BBG's accounting department prepared and distributed to top management the comparative income statements presented below.
The accounting staff also prepared related financial information to assist management in evaluating the company's performance.BBG uses the FIFO inventory method for finished goods.Budgeted and fixed overhead are equal and the beginning inventory last year has $3.00/kg.of fixed overhead.
Required:
a.Explain to Gary Voss why BBG Corporation's net income decreased in the current fiscal year despite the sales price and sales volume increases.
b.A member of BBG's accounting department has suggested that the company adopt variable (direct)costing for internal reporting purposes.
(i)Prepare an operating income statement through income before taxes for the current year ended November 30,using the variable (direct)costing method.
(ii)Present a numerical reconciliation of the difference in income before taxes using the absorption costing method as currently employed by BBG and the proposed variable costing method.
c.Identify and discuss the advantages and disadvantages of using variable costing for internal reporting purposes.

---

Definitions:

Franklin Pierce

The 14th President of the United States (1853-1857), known for his pro-Southern views and policies that exacerbated sectional tensions leading up to the Civil War.

Whig Party

A political party active in the United States from the 1830s to the 1850s, advocating for federal government involvement in the economy and opposing the Democratic Party on issues regarding states' rights.

Free-Soil Party

A pre-Civil War political party in the United States that was opposed to the expansion of slavery into the western territories.

Congressional Elections

Elections held every two years in the United States to elect members to the House of Representatives and one-third of the Senate, determining the legislative makeup of Congress.