EXERCISE 7-9 (20 MINUTES)

3. By increasing production so that it exceeds sales, inventories will be

built up. This will have the effect of deferring fixed manufacturing over-

head in the ending inventory. How much fixed manufacturing overhead

must be deferred in this manner? The managers are suggesting an arti-

ficial boost to earnings of $328,000 since at the current rate of sales,

profit will only be $1,672,000 and they want to hit the target profit of

$2,000,000.

The amount of production, Q, required to defer $328,000 can be deter-

mined as follows:

Units in beginning inventory .. 0

Plus units produced ... Q

Units available for sale ... Q

Less units sold ... 400,000

Units in ending inventory ... Q – 400,000

Fixed manufacturing

overhead per unit = $6,888,000

Q

Case 7-19 (continued)

Fixed manufacturing Fixed manufacturing Number of

overhead deferred = overhead rate × units added

in inventory per unit to inventory

$6,888,000

$328,000 = × (Q - 400,000)

$328,000 × Q = $6,888,000 × (Q - 400,000)

$328,000 × Q = $6,888,000 × Q - $6,888,000 × 400,000

$6,560,000 × Q = $6,888,000 × 400,000

Q = 420,000 units