Solar Manufacturing Company is a manufacturer of portable solar equipment. The costs involved in producing and marketing

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Question:

Solar Manufacturing Company is a manufacturer of portable solar equipment. The costs involved in producing and marketing a unit of solar equipment are as follows:

Cost item Cost per unit (RM) Total (RM)

Direct material 12

Direct labor 6

Variable manufacturing overhead 5

Fixed manufacturing overhead 7

Variable sales and administration expenses 3

Fixed sales and administration expenses RM100,000

Market research made by the Solar Manufacturing Company expects high demand for this solar equipment due to the savings in electricity consumption. The total pre-tax profit reported for the first year of operations is as follows:

Solar Manufacturing Company Income Statement For the period ended First Year

Sales (RM40 per unit) RM 2,000,000

Minus: Cost of Goods Sold 1,500,000

Gross profit 500,000

Minus: Sales and administrative expenses 250,000

Pre-tax profit RM 250,000

In the first year of operation, Solar Manufacturing Company has produced a total of 10,000 units of solar equipment in excess of the actual sales unit. This is because the amount of actual sales is less than the expected sales. However, the Company believes sales in the second year will increase. During the second year of operations, variable costs per unit and fixed costs were the same, while the selling price also remained unchanged. The Company has produced 50,000 units of solar equipment and sold 60,000 units in the second year. The actual unit of production is less than 10,000 units of normal production due to machine damage. However, management is satisfied with the 20% increase in sales units. Manufacturing overheads are applied based on actual production units. Any variance of manufactured overheads is considered immaterial

Required:

a) Prepare the income statement for Solar Manufacturing Company for the second year using the following methods:

i) Absorption costing (full).

ii) Variable costing (marginal).

b) Explain why there is a difference in the net income figures reported in both methods. Support your explanation with calculations.

c) Based on the Marginal Income Statement provided in (a) (ii) above:

vi) Determine the break-even point in units and Malaysian Ringgit.

vii) How much revenue should be generated to earn a net income after tax of RM150,000? Assume the tax rate is 40%. Also, calculate the margin of safety in Malaysian Ringgit.

viii) The Company plans to increase advertising expenditure of RM30,000 as it expects to increase sales by 2,000 units. What is the effect of this plan on the profits of the Company? Should the Company continue?

ix) If direct labour costs increase by 20% of the original cost of RM6, determine the selling price for a unit of solar equipment that must be charged to maintain the current contribution margin ratio.

x) Calculate the Company's operating leverage. If sales increase by 10%, what is the estimated increase in profit?