Reference no: EM132507911

The Jarvis Company uses an absorption costing system. Total variable manufacturing costs, including direct material costs, were $3 per unit; the standard production rate was 10 units per machine hour. For 2008, total budgeted and actual fixed manufacturing costs were $420,000. Fixed manufacturing overhead was allocated using machine hours as the basis with the denominator volume being the annual achievable capacity of 60,000 machine hours. The selling price is $5 per unit. Variable marketing and administrative costs, which are driven by units sold, were $1 per unit. Fixed marketing and administrative costs were $120,000. Beginning inventory in 2008 was 30,000 units; ending inventory was 40,000 units. Sales in 2008 were 540,000 units. The same unit costs persisted throughout 2007 and 2008.

Question 1: Prepare absorption-costing based income statement to compute the income before taxes for 2008. Assume that all under/overapplied overhead is written off directly at year-end as an adjustment to cost of goods sold (i.e., compute gross margin and show the under/overapplied as a separate line item to adjust this gross margin). (Absorption costing-based income statement is also known as gross margin income statement.)

Question 2: Prepare income statement to compute the income before taxes if the firm uses variable costing (also known as contribution margin costing or direct costing)

Question 3: Reconcile any difference between the incomes computed in requirements 1 and 2 above with supporting calculations.

Question 4: Discuss one advantage and one disadvantage of using absorption-costing based income to reward managerial performance.