The demand for aloe vera hand lotion, one of numerous products manufactured by Smooth Skin Care Products 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 December 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 November or to suspend the manufacture of aloe vera hand lotion until December 1. The controller has assembled the following pertinent data:

Sales (400,000 units) $32,000,000
Cost of goods sold 28,330,000
Gross profit $3,670,000
Selling and administrative expenses 4,270,000
Loss from operations ($600,000)

The production costs and selling and administrative expenses, based on production of 400,000 units in October, are as follows:

Direct materials $15per unit
Direct labor 17per unit
Variable manufacturing cost 35per unit
Variable selling and administrative expenses 10 per unit
Fixed manufacturing cost $1,530,000 for October
Fixed selling and administrative expenses 270,000 for October

Sales for November are expected to drop about 20% below those of the preceding month. 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 aloe vera hand lotion. The inventory of aloe vera hand lotion at the beginning and end of November is expected to be inconsequential.

Required:
Prepare an estimated income statement in absorption costing form for November for aloe vera hand lotion, assuming that production continues during the month.

Answer:

Estimated loss from operations for aloe vera hand lotion in November = -$534,000.

Explanation:

The following calculations are done first:

Direct materials per unit = $15

Direct labor per unit = $17

Variable manufacturing cost per unit = $35

Fixed manufacturing cost per unit = Fixed manufacturing cost for October / Number of units in October = $1,530,000 / 400,000 = $3.825

Cost of goods sold per unit = Product cost per unit = Direct materials per unit + Direct labor per unit + Variable manufacturing cost per unit + Fixed manufacturing cost per unit = $15 + $17 + $35 + $3.825 = $70.825

Also, we have:

Expected sales in unit for November = Sales in unit for October * (100% - Expected percentage drop in sales) = 400,000 * (100% - 20%) = 320,00 units

Selling price per unit = Sales in October / Units sold in October = $32,000,000 / 400,000 = $80

Variable selling and administrative expenses per unit = $10

Fixed selling and administrative expenses for October = $270,000

Based on the above calculations, an estimated income statement in absorption costing form for November for aloe vera hand lotion can be prepared as follows:

                     Smooth Skin Care Products Inc.

     Estimated Income Statement for Aloe Vera Hand Lotion

                             (Absorption Costing)

                                   For November

Particulars                                                                $            

Sales Revenue ($80 * 320,000)                     25,600,000

Cost of good sold ($70.825 * 320,000)        (22,664,000)

Gross profit                                                        2,936,000

Selling and administrative expenses:

        Variable ($10 * 320,000)                         (3,200,000)

         Fixed                                                         (270,000)  

Loss from operations                                       (534,000)  

Therefore, we have:

Estimated loss from operations for aloe vera hand lotion in November = -$534,000

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