Question

Carlos Cavalas, the manager of Echo Products’ Brazilian Division, is trying to set the production schedule for the last quarter of the year. The Brazilian Division had planned to sell 68,860 units during the year, but by September 30 only the following activity had been reported:

	Units
Inventory, January 1	0
Production	72,400
Sales	62,600
Inventory, September 30	9,800

The division can rent warehouse space to store up to 29,200 units. The minimum inventory level that the division should carry is 2,300 units. Mr. Cavalas is aware that production must be at least 5,880 units per quarter in order to retain a nucleus of key employees. Maximum production capacity is 45,300 units per quarter.

Demand has been soft, and the sales forecast for the last quarter is only 19,400 units. Due to the nature of the division’s operations, fixed manufacturing overhead is a major element of product cost.

Required:

1a. Assume that the division is using variable costing. How many units should be scheduled for production during the last quarter of the year?

1b. Will the number of units scheduled for production affect the division’s reported income or loss for the year? Yes or No?

2. Assume that the division is using absorption costing and that the divisional manager is given an annual bonus based on divisional operating income. If Mr. Cavalas wants to maximize his division’s operating income for the year, how many units should be scheduled for production during the last quarter?

Answer 1

SOLUTION

1A.

Desired inventory, December 31	2,300
Expected sales, Last quarter	19,400
Total needs	21,700
Less: Inventory, September 30	(9,800)
Required production	11,900

1B. The number of units scheduled for production will not affect the reported operating income or loss for the year if variable costing is in use. All fixed manufacturing overhead costs will be treated as an expense of the period regardless of the number of units produced. Thus, no fixed manufacturing overhead cost will be shifted between periods through the inventory account, and income will be a function of the number of units sold, rather than a function of the number of units produced and sold.

2.

Desired inventory, December 31	29,200
Expected sales, Last quarter	19,400
Total needs	48,600
Less: Inventory, September 30	(9,800)
Required production	38,800