Horace Company manufactures a professional-grade vacuum cleaner and began operations in 2020. For 2020, Horace budgeted to produce and sell 25,000 units. The company had no price, spending, or efficiency variances and writes off production-volume variance to cost of goods sold. Actual data for 2020 are as follows:. Data: Units produced 21,000 Units sold 18,500 Selling price $432 Variable cost: Manufacturing cost per unit produced: Direct materials $33 Direct manufacturing labor $23 Manufacturing Overhead $62 Marketing cost per unit sold $46 Fixed cost: Manufacturing costs $1,550,000 Administrative costs $906,000 Marketing costs $1,479,000
Requirements:
1. Prepare a 2020 income statement for Horace Company using variable costing.
2. Prepare a 2020 income statement for Horace Company using absorption costing.
3. Explain the differences in operating incomes obtained in requirements 1 and 2.
4. Horace​'s management is considering implementing a bonus for the supervisors based on gross margin under absorption costing. What incentives will this bonus plan create for the​ supervisors? What modifications could Horace management make to improve such a​plan? Explain briefly.

Horace Company

1. 2020 Income Statement using variable costing

Sales revenue                      $7,992,000

Variable Cost of goods sold:

Manufacturing costs            $2,183,000

Marketing cost per unit sold  $851,000

Contribution margin           $4,958,000

Fixed Costs:

Manufacturing costs $1,550,000

Administrative costs   $906,000

Marketing costs        $1,479,000

Total fixed costs =            $3,935,000

Net income =                     $1,023,000

2. 2020 Income Statement using absorption costing:

2. Sales revenue                      $7,992,000

Cost of goods sold:

Variable Manufacturing costs $2,478,000 ($118 * 21,000)

Fixed Manufacturing costs        1,550,000

Total cost of production         $4,028,000

Less Ending Inventory                 479,525

Cost of goods sold                 $3,548,475

Gross profit                            $4,443,525

Period costs:

Variable marketing costs $851,000

Fixed marketing costs     1,479,000

Administrative costs         906,000

Total period costs                $3,236,000

Net income                           $1,207,525

3. The differences that Horace obtains in the operating incomes under variable costing and absorption costing are due to the fixed manufacturing costs that are included in the ending inventory under absorption costing, making the cost of goods sold to be less and resulting in more profits. Under variable costing, the ending inventory does not include the fixed manufacturing costs.  So the cost of goods sold is higher, resulting in reduced profits.

4. A bonus for Horace's supervisors based on gross margin under absorption costing will entice supervisors to produce more and  sell less products so that the fixed costs can be carried forward.  Many products will be left in inventory at the end of the period, which is then carried forward to the following period, thus, enhancing the period's gross profit for maximum bonus for the supervisors.

Modifications that Horace management could make to improve the bonus plan is ensuring that production units do not exceed the budgeted sales units by a large margin and ensuring that ending inventory does not exceed an established limit.  This will entice the supervisors to produce according to market demand.

Explanation:

a) Data and Calculations:

Budgeted production and sales units for 2020 = 25,000

Actual production units for 2020 = 21,000

Actual sales unit for 2020 = 18,500

Ending inventory units for 2020 = 2,500

Selling price per unit = $432

Sales revenue = $7,992,000 ($432 * 18,500)

Variable cost:

Manufacturing cost per unit produced:

Direct materials                        $33

Direct manufacturing labor     $23

Manufacturing Overhead       $62 $118

Marketing cost per unit sold  $46

Total variable costs per unit $164

Fixed cost:

Manufacturing costs $1,550,000

Administrative costs   $906,000

Marketing costs        $1,479,000

Total fixed costs =   $3,935,000

1. 2020 Income Statement using variable costing

Sales revenue                      $7,992,000 ($432 * 18,500)

Variable Cost of goods sold:

Manufacturing costs            $2,183,000 ($118 * 18,500)

Marketing cost per unit sold  $851,000 ($46 * 18,500)

Contribution margin           $4,958,000 ($268 * 18,500)

Fixed Costs:

Manufacturing costs $1,550,000

Administrative costs   $906,000

Marketing costs        $1,479,000

Total fixed costs =            $3,935,000

Net income =                     $1,023,000

2. Sales revenue                      $7,992,000

Cost of goods sold:

Variable Manufacturing costs $2,478,000 ($118 * 21,000)

Fixed Manufacturing costs        1,550,000

Total cost of production         $4,028,000 (per unit = $191.81)

Less Ending Inventory                 479,525 ($191.81 * 2,500)

Cost of goods sold                 $3,548,475

Gross profit                            $4,443,525

Period costs:

Variable marketing costs $851,000

Fixed marketing costs     1,479,000

Administrative costs         906,000

Total period costs                $3,236,000

Net income                           $1,207,525

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