ACC 360 Cost Accounting

Smart Safety, a three-year-old company, has been producing and selling a single type of bicycle helmet. Smart Safety uses standard costing. After reviewing the income statements for the first three years, Stuart Weil, president of Smart Safety, commented, was told by our accountants and in fact, I have memorized that our breakeven volume is 52,000 units. I was happy that we reached that sales goal in each of our first two years.

 

But heres the strange thing: In our first year, we sold 52,000 units and indeed we broke even. Then in our second year we sold the same volume and had a positive operating income. I didnt complain, of course.but heres the bad part. In our third year, we sold 20% more helmets, but our operating income fell by more than 80% relative to the second year! We didnt change our selling price or cost structure over the past three years and have no price, efficiency, or spending variances. whats going on?

What denominator level is Smart Safety using to allocate fixed manufacturing costs to the bicycle helmets? How is Smart Safety disposing of any favorable or unfavorable production-volume variance at the end of the year? Please explain your answer.

Assuming the following are prevailing values of the helmet i.e. Selling Price=SP, Variable cost=VC and Fixed cost =FC

 Fixed Cost=FC                                        

Variable Cost=CP

Selling Price=SP                                 

                                             Yr. 1                                Yr. 2                                  Yr. 3

Sales Volume (units)              52000                                     52000                   =52000*1.2=62400

Sales Value     =52000*SP=$ 52000SP                              =$52000SP                       =62400SP

Less

 Variable Expenses=52000*$VC= ($52000VC)                 = ($52000VC)             = ($62400VC)

Contribution Margin=$52000SP-52000VC     =$52000SP-52000VC    =62400SP-$62400VC

Less Fixed Expenses     = (FC)                             = ($FC)                                            ?

                           Yr. 1                                             Yr. 2                                              Y3

N .O.I $52000SP-52000VC-FC   $52000SP-52000VC-FC      ($52000SP-52000VC-FC)*80%    

N.O.I =net operating income                             

From the above illustration it is explained that as the sales unit increases in financial year 3 likewise fixed expenses are seen to change upwards due to fixed volume variance method allocation. Fixed volume variance is method is seen to be contributed by variance resulting from changes in actual output volume production level in addition with the denominator concept that are either budgeted or factory Garrison (2010, Pg.793). The Smart Safety firm changes in net operating income is controlled by the denominator budgeted production level that result from the allocation of values of the difference in actual production and that which is budgeted or planned for. Fixed cost is seen to mostly depend on the level of production hence the higher the difference the greater the impact on the net operating income.

Additional allocation of fixed overhead cost at Smart Safety firm due to the increase of actual production of 62400 units against the 52000 units that is causing favorable volume variance according to Roth (2008.Pg 12) is what has greatly minimized the firm’s net operating income.

Conclusion is therefore drawn to the allocation of fixed overheads through the budgeted production level method to be highly contributing to the changes in net income despite the fact that sales and other factors are constant as illustrated above. This, therefore, affects the breakeven point at Smart Systems from the constant units of 52000 to 62400.

References

Garrison, R. H., Noreen, E. W., Brewer, P. C., & McGowan, A. (2010). Managerial accounting.

Issues in Accounting Education, 25(4), 792-793.

Roth, H. P. (2008). Using cost management for sustainability efforts. Journal of Corporate

Accounting & Finance, 19(3), 11-18.