Starfax, InC., manufactures a small part that is widely used in various electron

Question

Starfax, InC., manufactures a small part that is widely used in various electronic products such as home computers. Operating results for the first three years of activity were as follows (absorption costing basis) Year 1 Year 3 Sales Cost of goods sold Year 2 $800,000 $ 640,000 $800,000 580,000 400,000 620,000 Gross margin Selling and administrative expenses 220,000 240,000180,000 190,000 180,000 190,000 Net operating income (loss) $30,000 60,000 $(10,000) In the latter part of Year 2, a competitor went out of business and in the process dumped a large number of units on the market. As a result, Starfax's sales dropped by 20% during Year 2 even though production increased during the year. Management had expected sales to remain constant at 50,000 units; the increased production was designed to provide the company with a buffer of protection against unexpected spurts in demand. By the start of Year 3, management could see that inventory was excessive and that spurts in demand were unlikely. To reduce the excessive inventories, Starfax cut back production during Year 3, as shown below: Year 2 Year 3 40,000 50,000 Year 1 Production in units Sales in units 50,000 50,000 60,000 40,000

Explanation / Answer

1.

2.-a

2-b.

Working:

5-b.

Working:

STARFAX INC. Contribution format income statement Year 1 Year 2 Year 3 Sales units 50000 40000 50000 Sales 800000 640000 800000 Variable expenses: Variable cost of goods sold ($2 per unit) 100000 80000 100000 Variable selling and administrative ($1 per unit) 50000 40000 50000 Total variable expenses 150000 120000 150000 Contribution margin 650000 520000 650000 Fixed expenses: Fixed manufacturing expenses 480000 480000 480000 Fixed selling and administrative expenses 140000 140000 140000 Total fixed costs 620000 620000 620000 Net operating income (loss) 30000 -100000 30000

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