Question

Sampson Company operates a manufacturing facility where several products are made. Each product is considered a business segment, and the product managers have the opportunity to receive a bonus based on the profit of the segment. Franco Hopper is the manager for the scissors product line. Production and sales data for the scissors product line for the past three years are shown below:

Year 1 Year 2 Year 3 Units produced 100,000 units 125,000 units 160,000 units Units sold 100,000 units 100,000 units 100,000 units Sales price per unit \( 12.00 per unit \) 12.00 per unit $ 12.00 per unit Variable manufacturing cost per unit 5.00 per unit 5.00 per unit 5.00 per unit Total fixed manufacturing costs 200,000 per year 200,000 per year 200,000 per year

Hopper’s bonus is 0.5% of the gross profit of the scissors product line, based on absorption costing. Upper management is discussing changing the bonus system so that bonuses are based on operating income using variable costing. Hopper is opposed to this change and has been trying to convince the other product managers to join him in voicing their opposition. There are no beginning inventories in Year 1.

Requirements:

1. Calculate the fixed cost per unit produced for each year.
2. Prepare income statements for the three years using absorption costing.
3. Calculate Hopper’s bonus based on the current plan.
4. Prepare income statements for the three years using variable costing.
5. Calculate Hopper’s bonus based on the proposed plan.
6. Give possible reasons why Hopper is opposed to the proposed bonus plan. Do you think Hopper’s actions have been ethical the past three years? Why or why not?

Short answer

Requirements	Year 1	Year 2	Year 3
Fixed cost per unit	$2	$1.6	$1.25
Operating income under absorption costing	$497,500	$537,300	$572,125
Hopper’s bonus for current plan	$2500	$2700	$2875
Operating income under variable costing	$500,000	$500,000	$500,000
Hopper’s bonus on the proposed plan	$2500	$2500	$2500

Step-by-step solution

Meaning of Absorption Costing

Absorption costing is a method used to determine a product's cost by considering all the direct costs and fixed and variable manufacturing overheads.

Calculation of the fixed cost per unit for each year

Particulars	Year 1	Year 2	Year 3
Fixed cost	$200,000	$200,000	$200,000
Units produced	100,000	125,000	160,000
Fixed cost per unit	$2	$1.6	$1.25

 Income statement under absorption costing

Particulars	Year 1	Year 2	Year 2
Net sales revenue	$1,200,000	$1,200,000	$1,200,000
Less: Cost of goods sold	$700,000	$660,000	$625,000
Gross profit	$500,000	$540,000	$575,000
Variable selling and administrative cost (0.5% of gross profit)	$2,500	$2,700	$2,875
Operating Income	$497,500	$537,300	$572,125

Working note:

Calculation of cost of goods sold:

years	Variable cost per unit (a)	Fixed cost per unit (b)	Cost of goods sold per unit (a+b)	Cost of goods sold
Year 1	$5	$2	$7	$7,00,000
Year 2	$5	$1.6	$6.6	$660,000
Year 3	$5	$1.25	$6.25	$625,000

Note: Taking variable selling and administrative cost 0.5% on gross profit because the company is giving a bonus to hopper’s 0.5%, and it is based on the gross profit earned on sales, so it is an expense of variable nature to the company.

Calculation of Hopper’s bonus on the current plan

Particulars	Year 1	Year 2	Year 2
Gross profit	$500,000	$540,000	$575,000
Variable selling and administrative cost (0.5% of gross profit)	$2,500	$2,700	$2,875

Income statement under variable costing

Particulars	Year 1	Year 2	Year 2
Net sales revenue	$1,200,000	$1,200,000	$1,200,000
Less: Variable manufacturing cost	$500,000	$500,000	500,000
Contribution	$700,000	$700,000	$700,000
Fixed cost	$200,000	$200,000	$200,000
Operating Income	$500,000	$500,000	$500,000

Calculation of Hopper’s bonus on the proposed plan

Particulars	Year 1	Year 2	Year 2
Operating Income	$500,000	$500,000	$500,000
Variable selling and administrative cost (0.5% of Operating income)	$2,500	$2,500	$2,500

Profitability Analysis

Hopper is opposing the proposed plan because he will receive less amount of bonus under the proposed plan.