Memotec, Inc., manufactures and sells a unique electronic part. Operating results for the first three years of activity were as follows (absorption costing basis):

Sales dropped by 20% during Year 2 due to the entry of several foreign competitors into the market.
Memotec had expected sales to remain constant at 50,000 units for the year; production was set at 60,000 units in order to build a buffer of protection against unexpected spurts in demand. By the start of Year 3, management could see that spurts in demand were unlikely and that the inventory was excessive. To work off the excessive inventories, Memotec cut back production during Year 3, as shown below:

Additional information about the company follows:
a. The company's plant is highly automated. Variable manufacturing costs (direct materials, direct labor, and variable manufacturing overhead) total only $4 per unit, and fixed manufacturing overhead costs total $600,000 per year.
b. Fixed manufacturing overhead costs are applied to units of product on the basis of each year's production. (That is, a new fixed overhead rate is computed each year, as in Exhibit 7–7).
c. Variable selling and administrative expenses are $2 per unit sold. Fixed selling and administrative expenses total $70,000 per year.
d. The company uses a FIFO inventory flow assumption.
Memotec's management can't understand why profits tripled during Year 2 when sales dropped by 20%, and why a loss was incurred during Year 3 when sales recovered to previous levels.

Required:
1. Prepare a contribution format income statement for each year using variable costing.
2. Refer to the absorption costing income statements above.
a. Compute the unit product cost in each year under absorption costing. (Show how much of this cost is variable and how much is fixed.)
b. Reconcile the variable costing and absorption costing net operating income figures for each year.
3. Refer again to the absorption costing income statements. Explain why net operating income was higher in Year 2 than it was in Year 1 under the absorption approach, in light of the fact that fewer units were sold in Year 2 than in Year 1.
4. Refer again to the absorption costing income statements. Explain why the company suffered a loss in Year 3 but reported a profit in Year 1, although the same number of units was sold in each year.
5. a. Explain how operations would have differed in Year 2 and Year 3 if the company had been using Lean Production with the result that ending inventory was zero.
b. If Lean Production had been in use during Year 2 and Year 3, what would the company's net operating income (or loss) have been in each year under absorption costing? Explain the reason for any differences between these income figures and the figures reported by the company in the statementsabove.

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Year 1 Year 2 ear Sales. . $1,000,000 $800,000 $1,000,000 Cost of goods sold: Beginning inventory Add cost of goods manufactured Goods available for sale..^ ^^. Less ending inventory. 280,000 760,000 800,000 840,000 1,040,000 190,000 850,000 150,000 170,000 $30,000 90,000 (20,000) 0 800,000 840,000 0 .. Cost of goods sold Gross margin Selling and administrative e Net operating income (loss) 0 280,000 800,000 560,000 200,000 240,000 170,000 150,000 xpenses .. .. Year 1 Year 2 Year 3 Production in units 50,000 60,000 40,000 50,000 40,000 50,000