Safety Chemical produces and sells an ice-melting granular used on roadways and sidewalks in winter. It annually produces and sells about 100 tons of its granular. In its nine-year history, the company has never reported a net loss. However, because of this year’s unusually mild winter, projected demand for its product is only 65 tons. Based on its predicted production and sales of 65 tons, the company projects the following income statement (under absorption costing).
Sales (65 tons at $21,000 per ton) $1,365,000
Cost of goods sold (65 tons at $16,000 per ton) 1,040,000
Gross margin 325,000
Selling and administrative expenses 345,800
Net loss $ (20,800)
Its product cost information follows and consists mainly of fixed cost because of its automated production process requiring expensive equipment.
Variable direct labor and material costs per ton $ 4,615
Fixed cost per ton ($740,000 ÷ 65 tons) 11,385
Total product cost per ton $ 16,000
Selling and administrative expenses consist of variable selling and administrative expenses of $320 per ton and fixed selling and administrative expenses of $325,000 per year. The company’s president is concerned about the adverse reaction from its creditors and shareholders if the projected net loss is reported. The operations manager mentions that since the company has large storage capacity, it can report a net income by keeping its production at the usual 100-ton level even though it expects to sell only 65 tons. The president was puzzled by the suggestion that the company can report income by producing more without increasing sales.
1.1 Can the company report a net income by increasing production to 100 tons and storing the excess production in inventory?
1.2 Prepare an income statement (using absorption costing) based on production of 100 tons and sales of 65 tons.
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