Headgear Inc
18-2 Full Versus Variable Costing and Ethical Issues
HeadGear, Inc is a small manufacturer of headphones for use in commercial and personal applications. The HeadGear headphones are known for their outstanding sound quality and light weight, which makes them highly desirable especially in the commercial market for telemarketing firms and similar communication applications, despite the relatively high price. Although demand has grown steadily, profits have grown much more slowly, and John Hurley, the CEO, suspects productivity is falling, and costs are rising out of hand. John is concerned that the decline in profit growth will affect the stock price of the company and inhibit the firm's efforts to raise new investment capital, which will be needed to continue the firm's growth. While the firm is now operating at 68% of available production capacity, John thinks the market growth will soon exceed available capacity.
To improve profitability, John has decided to bring in a new COO with the objective of improving profitability very quickly. The new COO understands that profits must be improved within the coming 10-18 months. A bonus of 10% of profit improvement is promised the new COO if this goal is achieved. The following is the income statement for HeadGear for 2010, from the most recent annual report. Product costs for HeadGear include $25 per unit variable manufacturing costs and $1,920,000 per year fixed manufacturing overhead. Budgeted production was 120,000 units in 2010. Selling and administrative costs include a variable portion of $15 per unit and a fixed portion of $2,400,0000 per year. The same units costs and production level are also applicable for 2009.
HeadGear Inc.
Income Statement for the Period Ended 12/31/2010
Sales (125,000 @$75) $ 9,375,000
Cost of Sales: Beginning Inv: 5,000 @ $41 $ 205,000 Cost of Production: 120,000 @ $41 4,920,000 Goods Available: 130,000 $5,125,000 Less Ending Inv: 0 @ $41 -0- $5,125,000
Gross Margin $4,250,000
HeadGear, Inc is a small manufacturer of headphones for use in commercial and personal applications. The HeadGear headphones are known for their outstanding sound quality and light weight, which makes them highly desirable especially in the commercial market for telemarketing firms and similar communication applications, despite the relatively high price. Although demand has grown steadily, profits have grown much more slowly, and John Hurley, the CEO, suspects productivity is falling, and costs are rising out of hand. John is concerned that the decline in profit growth will affect the stock price of the company and inhibit the firm's efforts to raise new investment capital, which will be needed to continue the firm's growth. While the firm is now operating at 68% of available production capacity, John thinks the market growth will soon exceed available capacity.
To improve profitability, John has decided to bring in a new COO with the objective of improving profitability very quickly. The new COO understands that profits must be improved within the coming 10-18 months. A bonus of 10% of profit improvement is promised the new COO if this goal is achieved. The following is the income statement for HeadGear for 2010, from the most recent annual report. Product costs for HeadGear include $25 per unit variable manufacturing costs and $1,920,000 per year fixed manufacturing overhead. Budgeted production was 120,000 units in 2010. Selling and administrative costs include a variable portion of $15 per unit and a fixed portion of $2,400,0000 per year. The same units costs and production level are also applicable for 2009.
HeadGear Inc.
Income Statement for the Period Ended 12/31/2010
Sales (125,000 @$75) $ 9,375,000
Cost of Sales: Beginning Inv: 5,000 @ $41 $ 205,000 Cost of Production: 120,000 @ $41 4,920,000 Goods Available: 130,000 $5,125,000 Less Ending Inv: 0 @ $41 -0- $5,125,000
Gross Margin $4,250,000