5. a. With JIT, production would have been geared to sales in each year so
that little or no inventory of finished goods would have been built up
in either Year 2 or Year 3.
b. If JIT had been in use, the net operating income under absorption
costing would have been the same as under variable costing in all
three years. With production geared to sales, there would have been
no ending inventory, and therefore there would have been no fixed
manufacturing overhead costs deferred in inventory to other years.
Assuming that the company expected to sell 50,000 units in each
year and that unit product costs were set on the basis of that level of
expected activity, the income statements under absorption costing
would have appeared as follows:
Year 1 Year 2 Year 3
Sales... $ 800,000 $ 640,000 $ 800,000
Less cost of goods sold:
Cost of goods manufac-
tured @ $11.60 per unit .... 580,000 464,000 * 580,000
Add underapplied overhead.. 96,000 **
Cost of goods sold ... 580,000 560,000 580,000
Gross margin ... 220,000 80,000 220,000
Less selling and administra-
tive expenses ... 190,000 180,000 190,000
Net operating income (loss) .... $ 30,000 $(100,000) $ 30,000
* 40,000 units × $11.60 per unit = $464,000.
** 10,000 units not produced × $9.60 per unit fixed manufacturing
overhead cost per unit = $96,000 fixed manufacturing overhead cost
not applied to products.
Case 7-18 (90 minutes)
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