P5-22 Sandi Scott obtained a patent on a small electronic device and organized Scott Products, Inc

PROBLEM 5-22 SANDI SCOTT
Absorption and Variable Costing: Production Constant, Sales Fluctuate (LO 5-1,
LO 5-2, LO 5-3)

Sandi Scott obtained a patent on a small electronic device and organized Scott Products, Inc. to
produce and sell the device. During the first month of operations, the device was very well
received on the market, so Ms. Scott looked forward to healthy profit. For this reason, she was
surprised to see a loss for the month on her income statement.
This statement was prepared by her accounting service which takes great pride in providing its
timely financial data. The statement follows:
Scott Products, Inc.
Income Statement
Sales (40,000 units)……………………………………                                                 $200, 000
Variable expenses
Variable cost of goods sold……………………………….                   $ 80,000
Variable selling and administrative expenses …                                              30,000                 110, 000
Contribution margin................................................                                                           90, 000

Fixed expenses
Fixed manufacturing overhead ……………………….                                    75, 000
Fixed selling and administrative expenses……….                               20, 000                              95, 000
Net operating loss …………………………………………                                                $ (5, 000)

Ms. Scott is discouraged over the loss for the month because she had planned to use the
statement to encourage investors to purchase stock in the new company. A friend who is a CPA,
insists that the company should be using absorption costing rather than variable costing. He
argues that if absorption costing had been used, the company would have reported a profit for
the month.
Selected cost data relating to the product and to the first month of operation follow:
Units produced ……………………………………………………………………... 50, 000
Units sold ………………………………………………………………………………. 40, 000
Variable cost per unit:
Direct materials………………………………………………………… $ 1.00
Direct labor …………………………………………………………..…. $ 0.80
Variable manufacturing overhead ……………………...…… $ 0.20
Variable selling and administrative expenses………….. $
0.75

REQUIRED: also does realistic computer animation for special effect in movies.
1. Complete the following:
a. Complete the product cost under absorption cost.
b. Redo the company’s income for the month using the absorption costing.
c. Reconcile the variable and absorption costing net operating income (loss) figures.
2. Was the CPA correct in suggesting that the company really earned a “profit” for the month?
Explain?
3. During the second month of operations, the company again produced 50,000 units but sold 60,000 units (Assume no change in total fixed costs).
a. Prepare a contribution format income statement for the month using variable costing.
b. Prepare an income statement for the month using the absorption costing.
c. Reconcile the variable costing net operating incomes.