Problem 1 -
The Children's Store is on Fifth Avenue in Chicago. It has a magic department near the main door. Management is considering dropping the magic department, which has consistently shown an operating loss. The predicted income statements, in thousands of dollars, are shown below.
The $300,000 of magic department fixed expenses includes the compensation of employees of $120,000. These employees will be terminated if the magic department is abandoned. All of the magic department's equipment is fully depreciated, so none of the $300,000 pertains to such items. Furthermore, disposal values of equipment will be exactly offset by the costs of removal and remodeling.
If the magic department is dropped, the manager will use the vacated space for either more general merchandise or more electronic products. The expansion of general merchandise would not entail hiring any additional salaried help, but more electronic products would require an additional person at an annual cost of $30,000. The manager thinks that sales of general merchandise would increase by $250,000; electronic products by $200,000. The manager's modest predictions are partially based on the fact that she thinks the magic department has helped lure customers to the store and, thus, improved overall sales. If the magic department is closed, that lure would be gone.
|
Total
|
General
Merchandise
|
Electronic
Products
|
Magic
Department
|
|
Sales
|
$6,000
|
$5,000
|
$400
|
$600
|
|
Variable expenses
|
4,090
|
3,500
|
200
|
390
|
|
Contribution margin
|
$1,910
|
$1,500
|
$200
|
$210
|
|
Fixed expenses*
|
1,100
|
750
|
50
|
300
|
|
Operating income (loss)
|
$810
|
$750
|
$150
|
($90)
|
Includes compensation, depreciation, property taxes, insurance, etc.
REQUIRED: Should the magic department be closed? Explain, showing computations.
Problem 2 -
Clean and Brite manufactures three different models of swimming pool cleaners (AR1, AR2, and BR1). These are sophisticated computer-controlled, programmed cleaners that scrub and vacuum the pool's bottom, and steps and provide supplemental filtration of pool water. The three models differ in their capacity and programmability.
Clean and Brite uses an absorption costing system that absorbs manufacturing overhead to the three models based on direct labor hours. The single plant wide manufacturing overhead rate is predetermined before the beginning of the fiscal year using a flexible manufacturing overhead budget. Variable manufacturing overhead is budgeted to be $3.00 per direct labor hour, and fixed manufacturing overhead is budgeted to be $1,397,500. Direct labor is budgeted at $25 per DLH. The following table summarizes the budgeted and actual results of operation for the year:
|
Models
|
|
AR1
|
AR2
|
BR1
|
|
Actual number of units produced
|
5,100
|
3,900
|
2,200
|
|
Actual DL hours per unit
|
3.1
|
4.2
|
5.9
|
|
Budgeted wholesale price
|
$550
|
$750
|
$1,050
|
|
Budgeted DL hours per scrubber
|
3
|
4
|
6
|
|
Budgeted direct materials
|
$95
|
$125
|
$175
|
|
Budgeted production (units)
|
5,000
|
4,000
|
2,000
|
|
Budgeted DL cost (@$25 per DL hour)
|
$75
|
$100
|
$150
|
REQUIRED:
1. Calculate the firm wide overhead rate at the beginning of the year (round to two decimals).
2. A batch of 100 units of model AR2 is produced using 405 direct labor hours. How much overhead is absorbed by this batch of 100 model AR2s?
3. Actual overhead incurred during the year was $1,520,500. Calculate the amount of over- or under absorbed overhead for the year.
4. Clean and Brite writes off any over/under absorbed to cost of good sold. What is the effect of writing off the over/under absorbed overhead calculated in (3) on net income? In other words, does net income increase or decrease after the write off?