HURLEY HAT COMPANY Income Statement Year Ended Decemoer 31, 2018 Net Sales Revenue $ 1,500,000 Cost of Goods Sold 700,000 Gross Profit 800,000 Selling and Administrative Expenses 500,000 Operating Income $ 300,000
The Hurley Hat Company manufactures baseball hats. Hurley’s primary customers are sporting goods stores that supply uniforms to youth baseball teams. Following is Hurley’s income statement for 2018:
In 2018, Hurley produced and sold 200,000 baseball hats. Of the Cost of Goods gold, $150,000 is fixed; 80% of the Selling and Administrative Expenses are fixed. There were no beginning inventories on January 1, 2018. The company is considering two options to increase sales.
Option 1: The company is operating at 100,000 hats below full production capacity and is considering increasing advertising to increase sales to the production capacity level in 2019. The marketing director predicts that an additional $100,000 expenditure for advertising Would increase sales to 300,000 hats per year.
Option 2: The sales manager has been negotiating with buyers for several national sporting goods retailers and recommends the company expand production capacity to 400,000 hats in order to secure long-term contracts beginning in 2019. The expansion is expected to increase fixed
Requirements
- Use the data from the 2018 income statement to prepare an income statement using variable costing. Assume no beginning or ending inventories. Calculate the contribution margin ratio. Round to two decimal places.
- Prepare an absorption costing income statement assuming the company pursues Option 1 and increases advertising and production and sales increase to 300,000 hats.
- Refer to the original data. Prepare an absorption costing income statement assuming the company pursues Option 2 and increases capacity and sales and production increases to 400,000 total hats.
- Which option should the company pursue? Explain your reasoning.
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