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Far North Telecom, Ltd
Far North Telecom, Ltd., of Ontario has organized a new division to manufacture and sell specialty cellular telephones. The division's monthly costs are shown below.
Manufacturing Costs:
Variable Cost per Unit:
Direct materials: $48
Variable manufacturing overhead: $2
Fixed manufacturing overhead costs (total): $360,000
Selling and administrative costs
Variable 12% of sales
Fixed (total): $470,00
Far North Telecom regards all of its workers as full-time employees and the company has a long-standing no layoff policy. Furthermore, production is highly automated. Accordingly, the company includes its labor costs in its fixed manufacturing overhead. The cellular phones sell for $150 each. During September, the first month of operations, the following activity was recorded:
Units produced: 12,000
Units sold;10,000
Required:
1. Compute the unit production cost under:
a. absorption costing
b. variable costing
2. Prepare an income statement for September using absorption costing.
3. Prepare an income statement for September using variable costing.
4. Assume that the company must obtain additional financing in order to continue operations. As a member of top management, would you prefer to rely on the statement in (2) above or on (3) above when meeting with a group of prospective investors?
5. Reconcile the absorption costing and variable costing net operating income figures in (2) and (3) above.
Expert Solution
PFA
When meeting the investors we would prefer to rely on 2 - absorption costing. This is because absorption costing better represents the state of affairs. The manufacturing costs should be held in inventory till goods are sold. This is what happens in absorption costing. The costs should be held in inventory under the matching concept. The costs incurred in production cannot be expenses unless the related units are sold. The revenue and the expense should be matched.
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