Prepare an income statement using absorption costing based on production of 42,000 tons and sales of 35,000 tons. Can the company report a positive income by increasing production to 42,000 tons and storing the 7,000 tons of excess production in inventory? 2. By how much does income increase by when producing 42,000 tons and storing 7,000 tons in inventory compared to only producing 35,000 tons?
Blazer Chemical produces and sells an ice-melting granular used on roadways and sidewalks in winter. It annually produces and sells 42,000 tons of its granular. Because of this year’s mild winter, projected demand for its product is only 35,000 tons. Based on projected production and sales of 35,000 tons, the company estimates the following income using absorption costing.
| Sales (35,000 tons at $129 per ton) | $ 4,515,000 |
|---|---|
| Cost of goods sold (35,000 tons at $96 per ton) | 3,360,000 |
| Gross profit | 1,155,000 |
| Selling and administrative expenses | 1,155,000 |
| Income | $ 0 |
Its product cost per ton follows and consists mainly of fixed overhead because its automated production process uses expensive equipment.
| Direct materials | $ 12 | per ton |
|---|---|---|
| Direct labor | $ 12 | per ton |
| Variable overhead | $ 6 | per ton |
| Fixed overhead ($2,310,000/35,000 tons) | $ 66 | per ton |
Selling and administrative expenses consist of variable selling and administrative expenses of $11 per ton and fixed selling and administrative expenses of $770,000 per year. The company’s president will not earn a bonus unless a positive income is reported. The controller mentions that because the company has large storage capacity, it can report a positive income by setting production at the usual 42,000 ton level even though it expects to sell only 35,000 tons. The president is surprised that the company can report income by producing more without increasing sales.
Required:
1. Prepare an income statement using absorption costing based on production of 42,000 tons and sales of 35,000 tons. Can the company report a positive income by increasing production to 42,000 tons and storing the 7,000 tons of excess production in inventory?
2. By how much does income increase by when producing 42,000 tons and storing 7,000 tons in inventory compared to only producing 35,000 tons?
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