In a normal year, Wilson Industries has $24,000,000 of fixed manufacturing costs

Question

In a normal year, Wilson Industries has $24,000,000 of fixed manufacturing costs and produces 60,000 units. In the current year, the demand for its product has decreased, and it appears that the company will be able to sell only 50,000 units. Senior managers are concerned, because their bonuses are tied to reported profit. In light of this, they are considering keeping production at 60,000 units.

Answer the following questions:

Explain why keeping the production at a level beyond the quantity needed for current sales will increase profit?

Discuss the impact of producing 10,000 "extra" units?

Is the managers' proposed action in the best interest of shareholders?

Explanation / Answer

If the production is kept beyond the quantity needed for current sales, it will result in generation of surplus stock of finished goods which will be shown as a credit to the profit and loss account and will eventually result in increase in profits.

Impact of producing 10,000 extra units

If 50,000 units were produced, $24,000,000 of fixed manufacturing costs would have been distributed on 50,000 units resulting in per unit fixed cost of $ 480

If 60,000 units were produced, $24,000,000 of fixed manufacturing costs would have been distributed on 60,000 units resulting in per unit fixed cost of $ 400

So, extra fixed cost borne by 50,000 units if 50,000 units were produced = $ 80 x 50,000 = $ 4,000,000 which would have resulted in reduction in profits by $ 4,000,000. Now, when extra units were produced, this resulted in increase in closing stock valuation by $ 4,000,000 and subsequently increase in profits by $ 4,000,000.

The managers' proposed action is not in the best interest of shareholders as it has resulted in overstatement of profits and increase in manager's bonuses which has ultimately hurt the profits of the company.

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.