Absorption income statement

Upon receiving this figure, the president commented, “There’s something peculiar here. The controller says that the break-even point is 28,000 units per month. Yet we sold only 26,000 units in May, and the income statement we received showed a $2,000 profit. Which figure do we believe.” Prepare a brief explanation of what happened on the May income statement.

5-22 Absorption and Variable Costing; Product Constant, Sales Fluctuate

Sandi Scott obtained a patent on a small electronic device and organized Scott Products, Inc., to produce and sell the device. During the first month of operations, the device was very well received on the market, so Ms. Scott looked forward to a healthy profit. For this reason, she was surprised to see a loss for the month on her income statement. This statement was prepared by her accounting service, which takes great pride in providing its clients with timely financial data. The statement follows:

Scott Products, Inc.

Income Statement

Sales (40,000 units) $200,000

Variable expenses:

Variable cost of goods sold $80, 000

Variable selling and administrative expenses 30,000 110,000

Contribution margin 90,000

Fixed expenses:

Fixed manufacturing overhead 75,000 95,000

Fixed selling and administrative expenses 20,000 $ (5,000)

Net operating loss

Ms. Scott is discouraged over the loss shown for the month, particularly because she had planned to use the statement to encourage investors to purchase stock in the new company. A friend, who is a CPA, insists that the company should be using absorption costing rather than variable costing. He argues that if absorption costing had been used, the company would probably have reported a profit for the month.