Aristotle Constantinos, the manager of DuraProducts’ Australian Division, is trying to set the production schedule for the last quarter of the year. The Australian Division had planned to sell 100,000 units during the year, but current projections indicate sales will be only 78,000 units in total. By September 30 the following activity had been reported:
Units
Inventory, January 1. . . . . . . . . . . . . . 0
Production . . . . . . . . . . . . . . . . . . . . . 72,000
Sales . . . . . . . . . . . . . . . . . . . . . . . . . 60,000
Inventory, September 30 . . . . . . . . . . 12,000
Demand has been soft, and the sales forecast for the last quarter is only 18,000 units.
The division can rent warehouse space to store up to 30,000 units. The division should maintain a minimum inventory level of at least 1,500 units. Mr. Constantinos is aware that production must be at least 6,000 units per quarter in order to retain a nucleus of key employees. Maximum production capacity is 45,000 units per quarter.
Due to the nature of the division’s operations, fixed manufacturing overhead is a major element of product cost.
Required:
1. Assume that the division is using variable costing. How many units should be scheduled for production during the last quarter of the year? (The basic formula for computing the required production for a period in a company is: Expected sales + Desired ending inventory – Beginning inventory = Required production.) Show computations and explain your answer. Will the number of units scheduled for production affect the division’s reported profit for the year? Explain.
2. Assume that the division is using absorption costing and that the divisional manager is given an annual bonus based on the division’s net operating income. If Mr. Constantinos wants to maximize his division’s net operating income for the year, how many units should be scheduled for production during the last quarter? [See the formula in (1) above.] Explain.
3. Identify the ethical issues involved in the decision Mr. Constantinos must make about the level of production for the last quarter of the year.
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