Effects of differing production levels on absorption costing income: University Press produces textbooks for college courses. The company recently hired a new editor, Leslie White, to handle production and sales of books for an introduction to accounting course. Leslie’s compensation depends on the gross margin associated with sales of this book. Leslie needs to decide how many copies of the book to produce. The following information is available for the fall semester 2011:

Estimated sales 20,000 books

Beginning inventory 0 books

Average selling price $80 per book

Variable production costs $50 per book

Fixed production costs $400,000 per semester

The fixed cost allocation rate is based on expected sales and is

therefore equal to $400,000/20,000 books = $20 per book

Required

Leslie has decided to produce either 20,000, 24,000, or 30,000 books.

1. Calculate expected gross margin if Leslie produces 20,000, 24,000, or 30,000 books. (Make sure you include the production-volume variance as part of cost of goods sold.)

2. Calculate ending inventory in units and in dollars for each production level.

3. Managers who are paid a bonus that is a function of gross margin may be inspired to produce a product in excess of demand to maximize their own bonus. The chapter suggested metrics to discourage managers from producing products in excess of demand. Do you think the following metrics will accomplish this objective? Show your work.

a. Incorporate a charge of 10% of the cost of the ending inventory as an expense for evaluating the manager.

b. Include non-financial measures (such as the ones recommended on p. 311) when evaluating management and rewarding performance.