FRC: MANAGERIAL ACCOUNTING (Case 6 - Rayco, Inc.

Syndicate 1 - YP69B
1. Alya Salsabiila (29123004)
2. Wahyudi (29123005)
3. Annisa Wulandari (29123011)
4. Eugenia Maria Efendy (29123012)
5. Andika Yudhistira Ramadhan (29123131)

“These statements can’t be right,” said Ben Yoder, president of Rayco, Inc. “Our sales in the
second quarter were up by 25% over the first quarter, yet these income statements show a
precipitous drop in net operating income for the second quarter. Those accounting people
have fouled something up.” Mr. Yoder was referring to the following statements (absorption
costing basis):

After studying the statements briefly, Mr. Yoder called in the controller to see if the mistake in the
second quarter could be located before the figures were released to the press. The controller
stated, “I’m sorry to say that those figures are correct, Ben. I agree that sales went up during the
second quarter, but the problem is in production. You see, we budgeted to produce 15,000
units each quarter, but a strike on the west coast among some of our suppliers forced us to
cut production in the second quarter back to only 9,000 units. That’s what caused the
drop in net operating income.”

Mr. Yoder was confused by the controller’s explanation. He replied, “This doesn’t make sense. I
ask you to explain why net operating income dropped when sales went up and you talk about
production! So what if we had to cut back production? We still were able to increase sales by
25%. If sales go up, then net operating income should go up. If your statements can’t show a
simple thing like that, then it’s time for some changes in your department!”

Budgeted production and sales for the year, along with actual production and sales for the first
two quarters, are given below:
The company’s plant is heavily automated, and fixed manufacturing overhead amounts to
$180,000 each quarter. Variable manufacturing costs are $8 per unit. The fixed
manufacturing overhead is applied to units of product at a rate of $12 per unit (based on the
budgeted production shown on the prior page). Any underapplied or overapplied overhead is
closed directly to the cost of goods sold for the quarter. The company had 4,000 units in
inventory to start the first quarter and uses the FIFO inventory flow assumption. Variable
selling and administrative expenses are $5 per unit.

Required:
1. What characteristic of absorption costing caused the drop in net operating income for the
second quarter and what could the controller have said to explain the problem?

Under absorption costing, both production and sales affect the net operating income.
Fixed manufacturing overhead is treated as a product cost, so when units are produced,
a portion of fixed overhead is assigned to each unit. If some units remain unsold, the
fixed overhead cost stays in inventory. When these units are sold later, the fixed
overhead cost is released from inventory and included in the cost of goods sold.

The controller's explanation was accurate, but he could have mentioned that producing
fewer units resulted in a significant under-applied overhead. This unabsorbed overhead
is added to the cost of goods sold in the next quarter because the company couldn't
absorb all the fixed manufacturing overhead incurred.

2. Prepare a contribution format variable costing income statement for each quarter.

Known:
Sales Q1 = $ 480,000
Sales Q2 = $ 600,000
Actual Sales Q1 = 12,000 units
Actual Sales Q2 = 15,000 units
Fixed Mfg. OH = $ 180,000 / quarter
Fixed Mfg. OH = $ 12 / unit
Variable Mfg. OH = $ 8 / unit
Variable Selling & Adm Expenses = $ 5 / unit
3. Reconcile the absorption costing and the variable costing net operating income figures
for each quarter.

Q1 Q2
Variable cost net operating income 4,000 85,000
Deduct fixed manufacturing overhead
released from inventory during Q1 (4000* x
$12 per unit) (48,000)
Add fixed manufacturing overhead deferred
in inventory from Q1 to Q2 (7000* x $12 per
unit) 84,000 (84,000)
Add fixed manufacturing overhead deferred
in inventory from the Q2 to the future (1000*
x $12 per unit) 12,000
Absorption costing net operating income 40,000 13,000

*Inventory Flow

Q1 Q2

Beginning Inventory 4,000 7,000

Production 15,000 9,000

Sales (12,000) (15,000)

Ending Inventory 7,000 1,000

4. Identify and discuss the advantages and disadvantages of using the variable costing
method for internal reporting purposes.
Advantages:
● Help managers make better decisions about pricing, production, and marketing.
For example, variable costing can help managers identify which products are
most profitable and which products are not worth producing. Variable costing can
also help managers determine the break-even point for a product or service.
● Provides a more accurate picture of a company's profitability than absorption
costing. This is because variable costing only includes variable costs in the cost
of goods sold. This gives managers a better understanding of how much profit
they are making on each product or service.
● Variable costing is generally simpler to implement than absorption costing. This is
because variable costing does not require managers to allocate fixed costs to
products or services.
 Disadvantages:
● Variable costing is not generally accepted accounting principles (GAAP)
compliant. This means that companies cannot use variable costing for external
financial reporting.
● Variable costing can lead to the understatement of inventory value. This is
because variable costing does not include fixed costs in the cost of goods sold.
This can lead to inaccurate financial statements and make it difficult to compare a
company's financial performance to other companies.
● Variable costing can lead to poor long-term decision-making if managers focus
too much on short-term profitability. This is because variable costing does not
include fixed costs in the cost of goods sold. This can lead to managers making
decisions that reduce short-term profitability but increase long-term costs.

5. Assume that the company had introduced Lean Production at the beginning of the
second quarter, resulting in zero ending inventory. (Sales and production during the first
quarter remain the same.)
a. How many units would have been produced during the second quarter under
Lean Production?

Under Lean manufacturing, goods are produced to customer orders, and the goal
is to completely eliminate finished goods inventory and reduce in-process
inventory to almost nothing. Because of this, the company is expected to produce
only enough volume during the quarter to meet sales demand.

Unit Sold 15,000

Less : Units in inventory at the beginning of the quarter 7,000

Unit produced during the quarter 8,000

b. Starting with the third quarter, would you expect any difference between the net
operating income reported under absorption costing and under variable costing?
Explain why there would or would not be any difference.

From Q3 onwards, there will be little to no difference between reported earnings

in variable costing and absorption costing. Inconsistent development of net
operating income absorption costing profit and the difference in net operating
profit between absorption costing and variable costs that occur due to changes in
the number of units in inventory. There is no variation in fixed manufacturing
overhead costs between periods according to the absorption costing method.