Mastrolia Manufacturing produces pacifiers. The company uses absorption costing for external reporting, but management prefers variable costing for evaluating the profitability of each model. Bonuses, which make up a significant portion of each manager’s annual compensation, are based on attaining certain minimum gross margin percentages. Selected data regarding production and sales of the company’s popular “Little Eric” model follow:

Required:

1. Calculate Mastrolia’s gross profit percentage each year under generally accepted accounting principles. Briefly explain the reasons for any variations in the annual gross profit percentage.

2. Calculate Mastrolia’s gross profit percentage each year under variable costing. Briefly explain the reasons for any variations in the annual gross profit percentage.

3. If you were the manager of the “Little Eric” plant and your annual bonus was based on the plant achieving a gross profit percentage in excess of 15% each year, which method would you prefer and why? (Assume you can significantly influence annual production schedules.)

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20X0 20X1 20X2 $ 10.00 $ 4.00 $500,000 $ 10.000 4.00 $500,000 $ 10.00 $ 4.00 $500,000 Selling price per unit Variable production costs per unit Fixed production costs per year Beginning inventory 1/1/20X0 (FIFO basis) Units produced Units sold Ending inventory (units) 30,000 units @$8.00 (variable cost = $4.00) 125,000 100,000 55,000 100,000 85,000 115,000 140,000 45,000 70,000