Use the information below to answer the following question(s).
Following a strategy of product differentiation, Luke Company makes a high-end Appliance, AP15. Luke Company presents the following data for the years 1 and 2.
Luke Company produces no defective units but it wants to reduce direct materials usage per unit of AP15 in year 2. Manufacturing conversion costs in each year depend on production capacity defined in terms of AP15 units that can be produced. Selling and customer-service costs depend on the number of customers that the customer and service functions are designed to support. Neither conversion costs or customer-service costs are affected by changes in actual volume. Luke Company has 46 customers in year 1 and 50 customers in year 2. The industry market size for high-end appliances increased 5% from year 1 to year 2.
-What is the change in operating income from year 1 to year 2?

Question

Use the information below to answer the following question(s).
Following a strategy of product differentiation, Luke Company makes a high-end Appliance, AP15. Luke Company presents the following data for the years 1 and 2.
  Luke Company produces no defective units but it wants to reduce direct materials usage per unit of AP15 in year 2. Manufacturing conversion costs in each year depend on production capacity defined in terms of AP15 units that can be produced. Selling and customer-service costs depend on the number of customers that the customer and service functions are designed to support. Neither conversion costs or customer-service costs are affected by changes in actual volume. Luke Company has 46 customers in year 1 and 50 customers in year 2. The industry market size for high-end appliances increased 5% from year 1 to year 2.
-What is the change in operating income from year 1 to year 2?

Quizplus · Accepted Answer

According to the information given, there was a 5% increase in industry market size, but there was no change in the number of defective or sold units. Therefore, Luke Company's sales revenue would increase by 5%. On the other hand, Luke Company wants to reduce direct materials usage per unit, which would result in a decrease in variable costs and an increase in contribution margin per unit. However, manufacturing conversion costs in each year depend on production capacity, so it is not clear whether there would be any significant reduction in conversion costs. Customer-service costs depend on the number of customers, and since there was an increase in the number of customers, these costs would increase. Overall, it seems that the increase in sales revenue would offset the increase in customer-service costs, resulting in an increase in operating income. The correct answer is (C) $364,500 favourable.

Use the Information Below to Answer the Following Question(s)