Chapter 7, Problem 2PA

The demand for solvent, one of numerous products manufactured by Logan Industries Inc., has dropped sharply because of recent competition from a similar product. The company’s chemists are currently completing tests of various new formulas, and it is anticipated that the manufacture of a superior product can be started on November 1, one month in the future. No changes will be needed in the present production facilities to manufacture the new product because only the mixture of the various materials will be changed.

The controller has been asked by the president of the company for advice on whether to continue production during October or to suspend the manufacture of solvent until November 1. The following data have been assembled:

The production costs and selling and administrative expenses, based on production of 10,000 units in September, are as follows:

Sales for October are expected to drop about 40% below those of September. No significant changes are anticipated in the fixed costs or variable costs per unit. No extra costs will be incurred in discontinuing operations in the portion of the plant associated with solvent. The inventory of solvent at the beginning and end of October is not expected to be significant (material).

Instructions

1. 1. Prepare an estimated income statement in absorption costing form for October for solvent, assuming that production continues during the month.
2. 2. Prepare an estimated income statement in variable costing form for October for solvent, assuming that production continues during the month.
3. 3. What would be the estimated operating loss if the solvent production were temporarily suspended for October?
4. 4. What advice should you give to management?