Question

Blazer Chemical produces and sells an ice-melting granular used on roadways and sidewalks in winter. It annually produces and sells about 100 tons of its granular. In its nine-year history, the company has never reported a net loss. However, because of this year's unusually mild winter, projected demand for its product is only 65 tons. Based on its predicted production and sales of 65 tons, the company projects the following income statement (under absorption costing).

Sales (65 tons at $20,000 per ton)	$	1,300,000
Cost of goods sold (65 tons at $15,000 per ton)		975,000
Gross margin		325,000
Selling and administrative expenses		345,800
Net loss	$	(20,800	)

  
Its product cost information follows and consists mainly of fixed cost because of its automated production process requiring expensive equipment.

Variable direct labor and material costs per ton	$	3,615
Fixed cost per ton ($740,000 ÷ 65 tons)		11,385
Total product cost per ton	$	15,000

Selling and administrative expenses consist of variable selling and administrative expenses of $320 per ton and fixed selling and administrative expenses of $325,000 per year. The company's president is concerned about the adverse reaction from its creditors and shareholders if the projected net loss is reported. The operations manager mentions that since the company has large storage capacity, it can report a net income by keeping its production at the usual 100-ton level even though it expects to sell only 65 tons. The president is puzzled by the suggestion that the company can report income by producing more without increasing sales.


Required:
1. Can the company report a net income by increasing production to 100 tons and storing the excess production in inventory? Complete the following income statement (using absorption costing) based on production of 100 tons and sales of 65 tons. (Round your answers to the nearest whole dollar.)

Answer 1

Yes, under absorption costing, a company can report a higher net income amount by producing more units than they sell.

	65 tons	100 tons
Variable direct labor and material per ton	3,615	3,615
Fixed overehad per ton	11,385	7,400
Cost of goods sold per unit	15,000	11,015
Number of tons sold	65	65
Total cost of goods sold	975,000	715,975

Sales volume- 65 tons	65 tons	100 tons
Sales	1,300,000	1,300,000
Cost of goods sold	(975,000)	(715,975)
Gross margin	325,000	584,025
Selling expenses	(345,800)	(345,800)
Net Income/ (Loss)	(20,800)	238,225