Solved: Mark Hancock Inc manufactures a specialized

surgical instrumen

Mark Hancock, Inc. manufactures a specialized surgical instrument called the HAN-20. The firm
has grown rapidly in recent years because of the product’s low price and high quality. However,
sales have declined this year due primarily to increased competition and a decrease in the
surgical procedures for which the HAN-20 is used. The firm is concerned about the decline in
sales, and has hired a consultant to analyze the firm’s profitability. The consultant has provided
the following information:

Hancock explained to the consultant that the unfavorable economic climate in 2009 and 2010
had caused the firm to reduce its price and production levels and reduce its fixed manufacturing
costs in response to the decline in sales. Even with the price reduction there was a decline in
sales in both 2009 and 2010. This led to an increase in inventory in 2009, which the firm was
able to reduce in 2010 by further reducing the level of production. In both years Hancock’s
actual production was less than the budgeted level so that the overhead rate for fixed overhead,
calculated from budgeted production levels, was too low and a production volume variance was
calculated to adjust cost of goods sold for the underapplied fixed overhead (the calculation of
the production-volume variance is explained fully in Chapter 15, and reviewed briefly below).
The production-volume variance for 2009 was determined from the fixed overhead rate of $175
per unit ($700,000/4,000 budgeted units). Since the actual production level was 200 units short
of the budgeted level in 2009 (4,000-3,800), the amount of the production-volume variance in
2009 was 200 x $175 = $35,000. The production-volume variance is underapplied (since actual
production level is less than budgeted) and is therefore added back to cost of goods sold to
determine the amount of cost of goods sold in the full-cost income statement. The full-cost
income statement for 2009 is shown below:

Required
1. Using the full-cost method, prepare the income statements for 2010.
2. Using variable costing, prepare an income statement for each period, and explain the
difference in income from that obtained in requirement 1.
3. Write a brief memo to the firm to explain the difference in operating income between variable
costing and fullcosting.

ANSWER
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