The Hadfield Company Manufactures and Sells a Unique Electronic Part

question 30

Essay

The Hadfield Company manufactures and sells a unique electronic part.The company's plant is highly automated with low variable and high fixed manufacturing costs.Operating results on an absorption costing basis for the first three years of activity were as follows:
$\begin{array}{|l|r|r|r|}\hline & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } \\\hline \text { Sales } & \$ 704,000 & \$ 528,000 & \$ 704,000 \\\hline \text { Cost of goods sold: } & & & \\\hline \begin{array}{l}\text { Beginning inventory }\end{array} & 0 & 0 & 220,000 \\\hline \begin{array}{l}\text { Cost of goods } \\\text { manufactured }\end{array} & \underline{520,000} & \underline{550,000} & \underline{496,000} \\\hline \begin{array}{l}\text { Goods available for } \\\text { sale }\end{array} & 520,000 & 550,000 & 716,000 \\\hline \begin{array}{l}\text { Less ending } \\\text { inventory }\end{array} & 0 & \underline{220,000} & \underline{186,000} \\\hline \text { Cost of goods sold } & 520,000 & 330,000 & 530,000 \\\hline \text { Gross margin } & 184,000 & 198,000 & 174,000 \\\hline \begin{array}{l}\text { Less selling and } \\\text { administrative } \\\text { expense }\end{array} & \underline{180,000} & \underline{160,000} & \underline{180,000} \\\hline \begin{array}{l}\text { Operating income } \\\text { (loss) }\end{array} & \$ 4,000 & \$ 38,000 & \$(6,000) \\\hline\end{array}$
Additional information about the company is as follows:
-Variable manufacturing costs (direct labour,direct materials,and variable manufacturing overhead)total $3 per unit,and fixed manufacturing overhead costs total $400,000.
-Fixed manufacturing costs are applied to units of product on the basis of the number of units produced each year (i.e.,a new fixed overhead rate is computed each year).
-The company uses a FIFO inventory flow assumption.
-Variable selling and administrative expenses are $2 per unit sold.Fixed selling and administrative expenses total $100,000.
-Production and sales information for the three years is as follows:
$$\begin{array} { | l | l | l | l | } \hline & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } \\\hline \text { Production in units } & 40,000 & 50,000 & 32,000 \\\hline \text { Sales in units } & 40,000 & 30,000 & 40,000 \\\hline\end{array}$$
Required:
a)Compute operating income for each year under the variable costing approach.
b)Prepare a reconciliation from your Operating Income (loss)under variable costing to Absorption Costing operating income for year 3.
c)Referring to the absorption costing income statements above,explain why operating income was higher in Year 2 than in Year 1 under absorption costing,in light of the fact that fewer units were sold in Year 2 than in Year 1.
d)Referring again to the absorption costing income statements,explain why the company suffered an operating loss in Year 3 but reported a positive operating income in Year 1,although the same number of units was sold in each year.
e)If the company had used just-in-time (JIT)during Year 2 and Year 3 and produced only what could be sold,what would have been the company's operating income (loss)for each year under absorption costing.

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Definitions:

Outdoor Equipment

Gear and tools designed for activities conducted in natural environments, such as camping, hiking, and sports.

Design Fee

A charge levied for professional services related to the creation and planning of projects, products, or layouts.

Set-up Fees

Initial charges required to establish a service, account, or agreement before regular use or service can commence.

Commission Merchant

A person who performs services of buying and/or selling for a commission.