Question

Mace, Inc. is facing a problem with their 4th quarter absorption costing net operating income on December 25. Their net operating income target is $250,000 and the data so far is as follows:

Sales Revenue	$600,000	($200/unit)
Variable COGS	$240,000	($80/unit)
Fixed manufacturing overhead	$70,000
Fixed S&A	$50,000
Variable S&A: Commission on Sales	3%
Finished Goods Inventory as of December 25	350 units

Up until this quarter, Mace, Inc. has had a policy of having zero inventories at the end of each quarter. No further sales are possible during the year. Mr. S, the CEO, is planning to produce more units for inventory in the last week of December to meet the net operating income target.

(Q): How many additional inventory units above the December 25 Finished Goods balance need to be produced in the fourth quarter to meet the net operating income target if the sales commission is left unchanged? (Express your answer to the nearest whole number.)

Answer 1

The only way to meet the target profit is to increase the number of units produced so that the absorption costing is shared and hence overall costs reduce increasing our profits. We can do this as follows:

Sales	600,000
Less: Target Profit	250,000
Variable costs	240,000
Commission (600,000×3%)	18,000
Fixed selling and admin	50,000
Balance is for Fixed Manufacturing costs of units sold	42,000

So, manufacturing costs absorbed per unit sold = 42,000/3000 = $ 14 per unit.

We know the total fixed manufacturing costs are $ 70,000. So, Total Units to be produced = 70,000/14 =5000 units.

We already have sold 3000 units and having 350 in hand. So we need to produce 1650 (ie 5000-3000-350) units.