Required a. Prepare income statements based on full absorption costing and based

Question

Required

a. Prepare income statements based on full absorption costing and based on variable costing. Based

on the reported incomes using these methods, did Smooth Ride exceed the expectations of Ben

and Chris?

b. Smooth Ride follows generally accepted accounting standards. Which method, full absorption or

variable costing, will the company use to report its net income?

Business Decision Case Ben and Chris have been lifelong friends. They are engineer-minded and

have always dreamed of starting a manufacturing company. They want to manufacture tires, but

realize that this industry is heavily regulated and that achieving profitable operations will require

skillful management. Despite the odds, they form Smooth Ride, Inc., and resolve to only stay in

business if they report a positive net income after the company’s first year of operations. At the end

of 2016, its first year of operations, Smooth Ride reported the following summarized data:

Sales (105,000 tires)....................................... $13,125,000

Production costs (120,000 tires):

Direct material.......................................... 4,750,000

Direct labor ............................................ 3,675,000

Manufacturing overhead:

Variable ............................................... 2,300,000

Fixed ................................................. 950,000

Operating expenses:

Variable ............................................... 1,050,000

Fixed ................................................. 800,000

Depreciation on machinery ................................. 455,000

Property taxes ........................................... 330,000

Personnel department expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000

Explanation / Answer

SOLUTION:

Income Statement - Absorption Costing Sales (105,000 tires) 13,125,000 COGS Inventory Beginning nil Direct Material 4,750,000 Direct Labor 3,675,000 Manufacturing OH (fixed and variable) 3,250,000 Total Manufacturing Cost (120,000 tires) 11,675,000 Minus: Ending Inventory 1,459,375 ($11,675,000/120,000) * 15,000 = 1,459,375 COGS 10,215,625 Gross Profit 2,909,375 Operating Exp (fixed and variable) 1,850,000 Net Income/ Loss 1,059,375 Income Statement - Variable Costing Sales (105,000 tires) 13,125,000 COGS-Variable Inventory Beginning nil Direct Material 4,750,000 Direct Labor 3,675,000 Manufacturing OH (Variable) 2,300,000 Total Manufacturing Cost (120,000 tires) 10,725,000 Minus: Ending Inventory 1,340,625 (10,725,000/120,000) * 15,000 = 1,340,625 COGS-Variable 9,384,375 Manufacturing Margin 3,740,625 Operating Exp (Variable) 1,050,000 Contribution Margin 2,690,625 Minus: Fixed Costs and Expenses Manufacturing OH (Fixed) 950,000 Operating Exp (Fixed) 800,000 Total Fixed Costs and Expenses 1,750,000 Net Income 940,625

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