Headsmart a three year old company has been producing and selling a
Headsmart, a three-year-old company, has been producing and selling a single type of bicycle helmet. Headsmart uses standard costing. After reviewing the income statements for the first three years, Stuart Weil, president of Headsmart, commented, “I was told by our accountants—and in fact, I have memorized—that our breakeven volume is 50,000 units. I was happy that we reached that sales goal in each of our first two years. But, here’s the strange thing: in our first year, we sold 50,000 units and indeed we broke even. Then, in our second year we sold the same volume and had a positive operating income. I didn’t complain, of course . . . but here’s the bad part. In our third year, we sold 20% more helmets, but our operating income fell by more than 80% relative to the second year! We didn’t change our selling price or cost structure over the past three years and have no price, efficiency, or rate variances ... so what’s going on?!”
1. What denominator level is Headsmart using to allocate fixed manufacturing costs to the bicycle helmets? How is Headsmart disposing of any favourable or unfavourable production-volume variance at the end of the year? Explain your answer briefly.
2. How did Headsmart’s accountants arrive at the breakeven volume of 50,000 units?
3. Prepare a variable-costing-based income statement for each year. Explain the variation in variable costing operating income for each year based on contribution margin per unit and sales volume.
4. Reconcile the operating incomes under variable costing and absorption costing for each year, and use this information to explain to Stuart Weil the positive operating income in 2012 and the drop in operating income in 2013.
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