Omar Efenti is manager of the Pacific division of Zenna Inc. His division makes a single product that is sold to industrial customers. Demand is seasonable but is readily predictable. The division’s budget for 2010 called for production and sales of 120,000 units, with production of 10,000 units each month and sales varying between 8,000 and 13,000 units a month. The division’s budget for 2010 had an operating income of $780,000. 

By the end of November sales lagged projections, with only 105,000 units sold. Sales of 9,000 units were originally budgeted and are still expected in December. Production had remained stable at 10,000 units per month, and the cost of production had been exactly as budgeted: 

The division’s operating income for the first 11 months of 2010 was 

Omar Efenti receives an annual bonus only if his division’s operating income exceeds the budget. He sees no way to increase sales beyond 9,000 units in December.

Required 

1. From the budgeted and actual income statements shown, determine whether Zenna used variable or absorption costing. 

2. Suppose Zenna uses a standard absorption-costing system. (a) Compute the 2010 operating income if 10,000 units are produced and 9,000 units are sold in December. (b) How could Efenti achieve his budgeted operating income for 2010? 

3. Suppose Zenna uses a standard variable-costing system. (a) Compute the 2010 operating income if 10,000 units are produced and 9,000 units are sold in December. (b) How could Efenti achieve his budgeted operating income for 2010? 

4. Which system motivates Efenti to make the decision that is in the best interests of Zenna? Explain.

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Sales (120,000 × $50) Cost of goods sold (120,000 × $40) Gross margin Selling and administrative expenses (all fixed) Operating income $6,000,000 4,800,000 1,200,000 420,000 $ 780,000 Direct materials, 110,000 × $ 9 $ 990,000 Direct labour, 110,000 × $10 1,100,000 Variable overhead, 110 × $ 8 Fixed overhead Total production cost 880,000 1,430,000 $4,400,000