The Calais Company stresses competition between the heads of its various divisions, and it rewards stellar performance with year-end bonuses that vary between 5% and 10% of division net operating income (before considering the bonus or income taxes). The divisional managers have great discretion in setting production schedules.

The Brittany division produces and sells a product for which there is a long-standing demand but which can have marked seasonal and year-to-year fluctuations. On November 30, 20X0, Veronique Giraud, the Brittany division manager, is preparing a production schedule for December. The following data are available for January 1 through November 30 (€ is the symbol for euro, the currency for most countries of the European Union):

Beginning inventory, January 1, in units ………………………… 10,000

Sales price, per unit ………………………………………………. €  400

Total fixed costs incurred for manufacturing ……………… €  9,350,000

Total fixed costs: Other (not inventorial) ……………….. €10,200,000

Total variable costs for manufacturing ……………………. €18,150,000

Total other variable costs (fluctuate with units sold) ………. €  4,000,000

Units produced …………………………………………………. 110,000

Units sold ………………………………………………………. 100,000

Variances …………………………………………………………. None

Production in October and November was 10,000 units each month. Practical capacity is 12,000 units per month. Maximum available storage space for inventory is 25,000 units. The sales outlook for December–February is 6,000 units monthly. To retain a core of key employees, monthly production cannot be scheduled at less than 4,000 units without special permission from the president.

Inventory is never to be less than 10,000 units.

The denominator used for applying fixed factory overhead is regarded as 120,000 units annually.

The company uses a standard absorption-costing system. All variances are disposed of at year-end as an adjustment to standard cost of goods sold.

1. Given the restrictions as stated, and assuming that Giraud wants to maximize the company’s net income for 20X0, answer the following:

a. How many units should be scheduled for production in December?

b. What net operating income will be reported in 20X0 as a whole, assuming that the implied cost-behavior patterns will continue in December as they did throughout the year to date? Show your computations.

c. If December production is scheduled at 4,000 units, what would reported net income be?

2. Assume that standard variable costing is used rather than standard absorption costing.

a. What would net income for 20X0 be, assuming that the December production schedule is the one in part a of number 1?

b. What would net income for 20X0 be, assuming that December production was 4,000 units?

c. Reconcile the net incomes in this requirement with those in number 1.

3. From the viewpoint of the long-run interests of the company as a whole, what production schedule should the division manager set? Explain fully. Include in your explanation a comparison of the motivating influence of absorption and variable costing in this situation.

4. Assume standard absorption costing. Giraud wants to maximize her after-income tax performance over the long run. Given the data at the beginning of the problem, assume that income tax rates will be halved in 20X1. Assume also that year-end write-offs of variances are acceptable for income tax purposes. How many units should be scheduled for production in December? Why?