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Course: MBA 628/04/2015 Section A

Dr. Juan J. Segovia

Gomez Electronics, INC: Absorption Costing VS Direct Costing


Analysis

MA Business Consulting Company


Bahador Bakhtiari
Jason Dolgy
Ruying Kang
North Sprung-Much
Yuchen Yuan

February 2015

Gomez Electronics, INC Case Analysis Report

Goal definition: Leverage the benefits of direct costing method for the proper
business decisions and sales mix.
Quantitative Analysis:

Due to production inventory left, absorption costing system net income


($75,750) is higher than the direct costing system ($72,100). (Refer to
exhibit 1) (Q1)

Different income under the systems is caused by (Refer to exhibit 2)


(Q2):
o For Model A, the inventory was increased. Under direct costing the
$24,400 of fixed overhead cost incurred was expensed. While under
absorption costing, only a portion of the fixed MOH was expensed.
Model C has the similar situation. Model B has sales equal to
production, meaning it caused no income disparity.

Exhibit 1 shows that the actual net income is positive and the company is
making profit. But comparing to the budgeted net income, the company
didn't achieve the goal. (Q3)

Assuming the fixed MOH rate is the same, and the current fixed selling
expense can cover the new model C, then the proposal can bring in an
extra $18,750 of net income (Refer to exhibit 3). (Q4)

Qualitative Analysis:

The two costing methods give different results. The absorption costing
system may not truly reflect program needs and could result in
inequitable sales mix.

The direct costing system is more accurate in reflecting the net income
and it is better for the internal analysis and sales mix. (Q5)

Additional production of unit C should be considered to fulfill the unused


capacity as it currently operates at just over 50%.

Model B is the most profitable product following by model A and C.


Consider expanding capacity to produce it in long run as 100% of
production was sold in last 6 months.

Recommendations:
Use the direct costing system for the managerial decisions.
Gomez Electronics, INC Case Analysis Report

Accept the discount companys proposal.


Try to utilize the unused/excess capacity of department 3 by more
production of Model C and also having more contacts like the one is
offered by the discount company. It should be done as long as the sales
of the companys model B and A are not affected.

Gomez Electronics, INC Case Analysis Report

Appendix

Exhibit 1:
Comparative
Income
Statements, July
1-Decenber 31,
2002
Sales
Standard COGs
Standard Gross
Margin
Direct
Labor
Material
Variable
mfg.
overhead
Varian Fixed mfg.
ce
overhead
Total Variances
Total fixed overhead
Actual gross margin
Selling, general and
admin expense
Net income
Exhibit 2 : CVP
analysis based on
actual sales
SP
Production
Sales
Revenue
COGS (per unit)
Gross Margin (per
unit)
Total Contribution

Full Costing
Budgete
Actual
d sales
sales &
&Budget actual
ed
producti
productio on
n volume volume
$110,800 $99,700
0
0
835,500 753,250
272,500

243,750

Direct Costing
Budgeted
sales &
Production
volume

Actual Sales &


Actual
production
volume

$1108,000
777,000

$997,000
699,000

331,000

298,000

-3,400
-2,600

-3,400
-2,600

-200

-200

0
0
272,500

3,500
-2,700
0
241,050

0
58,500
272,500

0
-6,200
54,400
237,400

167,100
$105,400

165,300
$75,750

167,100
$105,400

165,300
$72,100

Absorption Costing
Direct Costing
Model
Model
Model
Model
Model A B
Model C A
B
C
47
52
37
47
52
37
8000
10000
4000
7000 10000
4000
$1000
$7000 $10000
$4000 $7000
0 $4000
32900 52000 14800
329000 520000 148000
0
0
0
35.75
39.5
27
32.7
36.45
26.4
$11.25

12.5

10

78750

125000

40000

Gomez Electronics, INC Case Analysis Report

14.3
10010
0

15.55
15550
0

10.6
42400

Fixed
Cost:
Fixed MOH
Selling
Admin*
Net income

0
57495.
7
$21,25
4

0
71869.
6
$53,13
0

0
35934.8
$4,065

24400
57495.
7
$18,20
4

30500
71869.
6
$53,13
0

3000
35934.
8
$3,465

* Assume the selling admin is fixed expense, and separate based on product volume,
each unit costs ~7$

Exhibit 3: Proposal of
Discount Company CVP
analysis
Current Model C
New Model C
SP
$37
$28.75
DL
9
9
DM
16
14
COG
Variable MOH
1.4
1.4
Total COGS
26.4
24.4
Contribution Margin
10.6
4.35
Sales Volume
4000
5000
Total Contribution Margin
42400
21750
Fixed MOH*
3000
3000
Fixed
Fixed Selling
Cost
admin**
35935
Net Income
$3,465
$1,8750
BEP point
3673
690
* Assume the fixe MOH rate of new model C is similar to current model C. Since
they have same production volume, so the total fixed MOH should be the same.
** Assume the current fixed selling admin expense can cover new Model C
sales.

Gomez Electronics, INC Case Analysis Report