Absorption Costing And Average Production Analysis For Rourk

Absorption Costing and Average Production Analysis for Rourke Inc and Others

This assignment involves analyzing various aspects of absorption costing, contribution margin format income statements, and operational decision-making for multiple companies, including Rourke Inc., Polarix, Kenai Kayaking, Lyon Furnaces, Down Jackets, Vanable, and Safety Chemical. Tasks include calculating changes in gross margin, preparing contribution margin income statements, converting absorption costing to variable costing, analyzing the impact of production levels on reported income, and evaluating special offers and production decisions based on cost and profitability. The assignment emphasizes understanding fixed and variable costs, production and sales relationships, inventory effects, and ethical considerations in financial reporting. Specific requirements involve performing calculations using given data, preparing income statements under different costing methods, and providing analysis for managerial decisions with supporting explanations and calculations.

Sample Paper For Above instruction

Understanding the nuances of absorption and variable costing methods is crucial for effective managerial decision-making and accurate financial reporting. This paper explores the impact of production levels, costing techniques, and operational decisions across several companies, illustrating key concepts through detailed calculations, income statement preparations, and analytical evaluations.

Impact of Increased Production on Rourke Inc.'s Gross Margin Under Absorption Costing

Rourke Inc. reports annual data with normal production and sales levels of 80,000 units, with a unit sales price of $58 and unit costs comprising direct materials ($11), direct labor ($8.50), variable overhead ($13), and fixed costs totaling $1,119,990. If the company increases its production to 120,000 units while maintaining sales at 80,000 units, the primary concern is how gross margin will change under absorption costing.

Absorption costing allocates fixed manufacturing overhead to units produced, affecting inventory valuation and gross margin. At 80,000 units, fixed overhead per unit is calculated as $1,119,990 / 80,000 = approximately $14 per unit. Increasing production to 120,000 units spreads fixed overhead over more units, reducing the per-unit fixed cost to $1,119,990 / 120,000 = approximately $9.33. Since sales remain unchanged at 80,000 units, 40,000 units will now be added to inventory, increasing inventory value and temporarily deferring some fixed overhead from cost of goods sold to ending inventory.

The gross margin under absorption costing is calculated as Sales Revenue minus Cost of Goods Sold (COGS). With 80,000 units sold at $58, revenue totals $4,640,000. COGS includes variable costs and a share of fixed overhead. Variable costs per unit are ($11 + $8.50 + $13) = $32.50. Fixed overhead allocated to sold units is 80,000 x $14 = $1,120,000. Total COGS thus equals (80,000 x $32.50) + (80,000 x $14) = $2,600,000 + $1,120,000 = $3,720,000, leading to a gross margin of $920,000.

When production increases to 120,000 units, and sales remain at 80,000, inventory increases by 40,000 units valued at the lower fixed overhead per unit ($9.33). The deferred fixed overhead in ending inventory increases revenues and gross margin by this amount, calculated as 40,000 x $4.67 (difference in fixed overhead per unit) = approximately $186,800. Therefore, gross margin increases by roughly this amount, totaling about $1,106,800, reflecting a rise of approximately $186,800 from the initial gross margin.

In conclusion, under absorption costing, the company's gross margin increases when production exceeds sales due to the deferral of fixed overhead costs in ending inventory. This highlights the impact of production volume decisions on reported profitability, emphasizing the importance of understanding inventory effects and cost behavior in managerial accounting (Drury, 2018; Garrison et al., 2021).

Contribution Margin Analysis for Polarix’s ATV Department

Polarix, a retailer selling all-terrain vehicles (ATVs), provides an income statement for its Consumer ATV Department, with sales amounting to $610,000 and a gross margin of $370,000. Variable selling expenses are $270 per ATV, while fixed selling and administrative expenses are fixed. The company purchases ATVs at $1,820 each, sells them at an average price of $4,200, and incurs a standard variable expense of $270 per unit.

To analyze contribution per ATV, we calculate the revenue per unit ($4,200), subtract variable costs ($270), and purchase cost ($1,820). The contribution margin per ATV equals $4,200 - $270 - $1,820 = $2,110. This figure indicates the amount each unit contributes toward covering fixed expenses and generating income. For total contribution, multiplying by units sold—80,000 ATVs—the total contribution margin is 80,000 x $2,110 = $168,800, reflecting the contribution of sales to fixed costs and profit.

When considering the contribution margin statement, fixed expenses, including fixed selling and administrative expenses, are deducted from total contribution margin to determine net income or loss. For instance, if fixed expenses are $150,000 (selling) plus $150,000 (administrative), totaling $300,000, net income would be $168,800 - $300,000 = -$131,200, indicating a loss at current sales levels. This analysis emphasizes the importance of contribution margins in assessing profitability and making decisions on pricing, sales volume, and cost management (Horngren et al., 2019; Hilton & Platt, 2013).

Conversion from Absorption to Variable Costing for Kayaking Manufacturing

Kenai Kayaking produces 1,025 kayaks at a total cost of $475 per kayak, which includes $375 variable and $100 fixed costs per unit. The company's absorption costing income statement reports sales of $794,250, gross margin of $220,000, and net income of $206,250 after fixed expenses of $95,000.

To convert income statement data from absorption to variable costing, the fixed manufacturing overhead assigned to inventory and cost of goods sold must be reallocated. Under variable costing, only variable production costs (here, $375 per kayak) are included in COGS, while fixed costs are expensed in total in the period.

The total fixed manufacturing overhead is $102,500 (fixed costs based on 1,025 kayaks), allocated to 1,025 units, resulting in $100 per kayak fixed overhead. For 775 kayaks sold, the fixed overhead included in COGS under absorption is 775 x $100 = $77,500. The variable cost of goods sold is 775 x $375 = $290,625. Adjusting for the fixed overhead, the contribution margin from sales becomes clearer: sales revenue minus variable COGS and variable selling expenses (not explicitly given here). Ultimately, the variable costing income statement shows a lower net income due to the expensing of fixed manufacturing overhead in total.

This conversion demonstrates that the difference between absorption and variable income statements primarily stems from fixed manufacturing overhead treatment, affecting reported income and inventory valuation, which is critical for internal decision-making and external reporting consistency (Weetman, 2019; Hilton & Platt, 2013).

Special Offer Analysis for Down Jackets

Down Jackets sells its products at $16.50 per jacket, with variable costs comprising production costs and utilities. Estimated costs for next month show a total variable cost per jacket of $42,000 / 6,000 = $7, and utilities costs based on high-low analysis suggest a variable component of $3 per jacket, with fixed costs of $56,000. When considering a special offer to sell 40 jackets at a discounted rate of $94 per night over three nights, the critical decision revolves around contribution margin.

The contribution margin per jacket under the offer is $94 - $7 (variable cost per jacket, including utilities) = $87. Since the hotel would reserve 40 suites for three nights, total revenue is 40 x $94 x 3 = $11,280. The total variable costs for the offer amount to 40 x $7 x 3 = $840. The contribution margin is then $11,280 - $840 = $10,440. Comparing this with the revenue if the offer is rejected implies evaluating whether the marginal contribution from the special offer justifies the occupancy, bearing in mind the fixed costs and the potential to utilize capacity efficiently. If the offered contribution exceeds skipped fixed costs and maintains stable fixed cost coverage, accepting the offer may be advantageous, especially during low-demand periods (Horngren et al., 2019; Hilton & Platt, 2013).

Ethical Considerations in Income Reporting: Absorption versus Variable Costing

Safety Chemical faces managerial and ethical dilemmas in reporting net income, particularly in a year with only 70 tons of demand, whereas production may be kept at 100 tons to report income. Under absorption costing, producing excess inventory can inflate reported profit by allocating fixed overhead to unsold units, thereby deferring expenses. This practice can misrepresent the company's financial health, misleading stakeholders and creditors. Ethical reporting mandates transparency and accuracy, emphasizing that management should report income based on actual sales and costs incurred, not manipulated production levels to influence earnings (Kieso et al., 2019; Bamber et al., 2020).

The analysis shows that increasing production to 100 tons without selling the excess inventory will not generate a net profit under the given costs, as the gross margin is insufficient to cover fixed expenses. Ethical guidelines in accounting discourage such practices that distort financial results. Managers must balance operational efficiency with truthful reporting, maintaining stakeholder trust and complying with accounting standards (ACA, 2021). Transparency in financial statements, disclosing inventory levels and costs, ensures that reported earnings reflect economic reality rather than managerial manipulation.

Conclusion

The comprehensive assessment of absorption and variable costing methods, managerial decisions on production and pricing, as well as ethical considerations in financial reporting, highlights the complexities faced by modern organizations. Accurate cost allocation, understanding inventory effects on profitability, and transparent disclosures are vital for sound managerial strategies and maintaining stakeholder confidence. Managers must evaluate the implications of their choices not only from a financial perspective but also considering ethical standards and long-term organizational reputation (Garrison et al., 2021; Hilton & Platt, 2013).

References

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