Variable and absorption costing

Variable and absorption costing

Variable and absorption costing, sales, and operating-income changes. Helmetsmart, a threeyear-
old company, has been producing and selling a single type of bicycle helmet. Helmetsmart uses standard
costing. After reviewing the income statements for the first three years, Stuart Weil, president of
Helmetsmart, commented, “I was told by our accountants—and in fact, I have memorized—that our breakeven volume is 49,000 units. I was happy that we reached that sales goal in each of our first two years. But, here’s the strange thing: In our first year, we sold 49,000 units and indeed we broke even. Then, in our second year we sold the same volume and had a positive operating income. I didn’t complain, of course . . .but here’s 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 didn’t change our selling price or cost structure over the past three years and have no price, efficiency, or spending variances . . . so what’s going on?!”

(see attachment)

Required

1. What denominator level is Helmetsmart using to allocate fixed manufacturing costs to the bicycle helmets?
How is Helmetsmart disposing of any favorable or unfavorable production-volume variance at
the end of the year? Explain your answer briefly.

2. How did Helmetsmart’s accountants arrive at the breakeven volume of 49,000 units?

3. Prepare a variable costing-based income statement for each year. Explain the variation in variable
costing operating income for each year based on contribution margin per unit and sales volume.

     4. Reconcile the operating incomes under variable costing and absorption costing for each year, and use
this information to explain to Stuart Weil the positive operating income in 2012 and the drop in operating
income in 2013.