Course: MBA 628/04/2015 Section A

Dr. Juan J. Segovia

Gomez Electronics, INC: Absorption Costing VS Direct Costing

Analysis

MA Business Consulting Company

Bahador Bakhtiari

Jason Dolgy

Ruying Kang

North Sprung-Much

Yuchen Yuan

February 2015

Gomez Electronics, INC Case Analysis Report

Goal definition: Leverage the benefits of direct costing method for the proper business decisions and sales mix.

Quantitative Analysis:

Due to production inventory left, absorption costing system net income ($75,750) is higher than the direct costing system ($72,100). (Refer to exhibit 1) (Q1)

Different income under the systems is caused by (Refer to exhibit 2) (Q2):

o For Model A, the inventory was increased. Under direct costing the $24,400 of fixed overhead cost incurred was expensed. While under absorption costing, only a portion of the fixed MOH was expensed. Model C has the similar situation. Model B has sales equal to production, meaning it caused no income disparity.

Exhibit 1 shows that the actual net income is positive and the company is making profit. But comparing to the budgeted net income, the company didn't achieve the goal. (Q3)

Assuming the fixed MOH rate is the same, and the current fixed selling expense can cover the new model C, then the proposal can bring in an extra $18,750 of net income (Refer to exhibit 3). (Q4)

Qualitative Analysis:

The two costing methods give different results. The absorption costing system may not truly reflect program needs and could result in inequitable sales mix.

The direct costing system is more accurate in reflecting the net income and it is better for the internal analysis and sales mix. (Q5)

Additional production of unit C should be considered to fulfill the unused capacity as it currently operates at just over 50%.

Model B is the most profitable product following by model A and C. Consider expanding capacity to produce it in long run as 100% of production was sold in last 6 months.

Recommendations:

Use the direct costing system for the managerial decisions.

Accept the discount company’s proposal.

Try to utilize the unused/excess capacity of department 3 by more production of Model C and also having more contacts like the one is offered by the discount company. It should be done as long as the sales of the company’s model B and A are not affected.

Gomez Electronics, INC Case Analysis Report

Appendix

Exhibit 1: Comparative Income Statements, July 1-Decenber 31, 2002

Full Costing Direct CostingBudgeted sales &Budgeted production volume

Actual sales & actual production volume

Budgeted sales & Production volume

Actual Sales & Actual production volume

Sales $110,8000 $99,7000 $1108,000 $997,000Standard COGs 835,500 753,250 777,000 699,000Standard Gross Margin 272,500 243,750 331,000 298,000

Variance

Direct Labor -3,400 -3,400Material -2,600 -2,600Variable mfg. overhead -200 -200Fixed mfg. overhead 3,500 0

Total Variances 0 -2,700 0 -6,200Total fixed overhead 0 0 58,500 54,400Actual gross margin 272,500 241,050 272,500 237,400Selling, general and admin expense 167,100 165,300 167,100 165,300Net income $105,400 $75,750 $105,400 $72,100

Exhibit 2 : CVP analysis based on actual sales

Absorption Costing Direct CostingModel A Model B Model C Model A Model B Model C

SP 47 52 37 47 52 37Production 8000 10000 4000 7000 10000 4000Sales $7000 $10000 $4000 $7000 $10000 $4000Revenue 329000 520000 148000 329000 520000 148000COGS (per unit) 35.75 39.5 27 32.7 36.45 26.4Gross Margin (per unit) $11.25 12.5 10 14.3 15.55 10.6Total Contribution 78750 125000 40000 100100 155500 42400Fixed Cost: Fixed MOH 0 0 0 24400 30500 3000 Selling Admin* 57495.7 71869.6 35934.8 57495.7 71869.6 35934.8Net income $21,254 $53,130 $4,065 $18,204 $53,130 $3,465

* Assume the selling admin is fixed expense, and separate based on product volume, each unit costs ~7$

Gomez Electronics, INC Case Analysis Report

Exhibit 3: Proposal of Discount Company CVP analysis Current Model C New Model CSP $37 $28.75

COG

DL 9 9DM 16 14Variable MOH 1.4 1.4

Total COGS 26.4 24.4Contribution Margin 10.6 4.35Sales Volume 4000 5000Total Contribution Margin 42400 21750

Fixed Cost

Fixed MOH* 3000 3000Fixed Selling admin** 35935

Net Income $3,465 $1,8750BEP point 3673 690

* Assume the fixe MOH rate of new model C is similar to current model C. Since they have same production volume, so the total fixed MOH should be the same.

** Assume the current fixed selling admin expense can cover new Model C sales.

Gomez Electronics, INC Case Analysis Report