ABC Inc. manufactures and sell product A. The sale price and costs on a per unit basis, when...

Question:

ABC Inc. manufactures and sell product A. The sale price and costs on a per unit basis, when 20,000 units per month are sold, are as follows:

Manufacturing costs:

Direct materials used $2.00

Direct labor $1.00

MOH variable $1.20

MOH fixed $1.10

Selling expenses:

Variable $4.00

Fixed $1.10

Sale price per unit $1

REQUIRED:

Each question is independent.

a. Present the income statement to calculate the annual operating income of ABC Inc.

ABC Inc.'s top management would like to improve profitability. The following strategy is implemented: decrease sale price by 10% to increase sales volume by 30%. The advertising budget should increase by $20,000.

b1. Calculate the impact of this strategy on ABC Inc.'s annual contribution margin.

b2. Calculate the impact on ABC Inc.'s annual operating income.

ABC Inc. received a special order from Africa Co., headquarter located in Zimbabwe, for 5,000 units at $6 each. The variable selling expenses on this special order will decrease by 40% and fixed expenses will increase by $5,000.

c1. Would you recommend to ABC Inc. to accept or reject the special order? Support your answer with appropriate computations.

c2. What is the lowest sale price that ABC Inc. should ask from Africa Co.? Show your computations?

c3. Provide and explain 3 qualitative factors, ABC Inc. should consider before making any decision to accept or reject the special order from Africa Co.

Income Statement:

The statement of revenue and expenses incurred during a year is known as income statement. It is a tool to measure the profitability of the entity and used by various parties. It is one of the statements of financial statements.

Answer and Explanation:

a. Preparation of income statement:

Particulars Amount ($)
Sales (20,000 X $1) 20,000
Less: Variable cost
Direct material (20,000 X 2) 40,000
Direct labor (20,000 X 1) 20,000
MOH Variable ( 20,000 X 1.2) 24,000
Contribution margin (64,000)
Less: MOH Fixed (20,000 X 1.10) 22,000
Selling expenses
Variable (20,000 X 4) 80,000
Fixed (20,000 X 1.1) 22,000
Net operating income (188,000)

B1. Calculation of contribution margin:

Particulars Amount ($)
Sales (26,000 X $0.90) 23,400
Less: Variable cost
Direct material (26,000 X 2) 52,000
Direct labor (26,000 X 1) 26,000
MOH Variable ( 26,000 X 1.2) 31,200
Contribution margin (85,800)

B2. Calculation of annual operating income:

Particulars Amount ($)
Contribution margin (85,800)
Less: MOH Fixed (26,000 X 1.10) 28,600
Selling expenses
Variable (26,000 X 4) 104,000
Fixed (26,000 X 1.1) 28,600
Advertising 20,000
Net operating income (267,000)

C1.

Particulars Amount ($)
Sales (5,000 X $9) 45,000
Less: Variable cost
Direct material (5,000 X 2) 10,000
Direct labor (5,000 X 1) 5,000
MOH Variable (5,000 X 1.2) 6,000
Variable selling expenses (5,000 X 4 X 60%) 12,000
Increase in fixed cost 5,000
Income (loss) (8,000)

ABC has to reject the order because it incurs the loss of $8,000.

C2. The lowest price that can be offered is $7.60 per unit ($38,000/5,000).

C3. The qualitative points to be consider in decision-making is as follows:

  • Discuss the payment terms with Africa Co. so as to eliminate any confusion.
  • Check the credibility of the Africa Co.
  • Check the sales chart and discount given to different customers and then check the profitability of the order.

Learn more about this topic:

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What Is an Income Statement? - Purpose, Components & Format

from Accounting 101: Financial Accounting

Chapter 2 / Lesson 2
45K

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