The numbers are simplified to ease computations this

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The numbers are simplified to ease computations. This problem avoids standard costing and its complications. 1. Variable-costing income statements: 2006 2007 Sales Production 1,000 units 1,400 units Sales Production 1,200 units 1,000 units Revenues ($3 per unit) $3,000 $3,600 Variable costs: Beginning inventory Variable cost of goods manufactured Cost of goods available for sale Deduct ending inventorya$ 0 700700 (200) $ 200 500700 (100) Variable cost of goods sold Variable operating costs Variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed operating costs Total fixed costs Operating income 500 1,000700 4001,5001,500 1,100$ 400600 1,200700 4001,8001,800 1,100$ 700a Unit inventoriable costs: Year 1: $700 ÷ 1,400 = $0.50 per unit; $0.50 × (1,400 – 1,000) Year 2: $500 ÷ 1,000 = $0.50 per unit; $0.50 × (400 + 1,000 – 1,200) 2. Absorption-costing income statements: 2006 2007 Sales Production 1,000 units 1,400 units Sales Production 1,200 units 1,000 units Revenues ($3 per unit) Cost of goods sold: Beginning inventory Variable manufacturing costs Fixed manufacturing costsaCost of goods available for sale Deduct ending inventoryb$ 0 700 7001,400 (400) $3,000 $ 400 500 7001,600 (240) $3,600 Cost of goods sold Gross margin Operating costs: Variable operating costs Fixed operating costs Total operating costs Operating income 1,000 4001,0002,000 1,400$ 6001,200 4001,3602,240 1,600$ 640aFixed manufacturing cost rate: Year 1: $700 ÷ 1,400 = $0.50 per unit Year 2: $700 ÷ 1,000 = $0.70 per unit bUnit inventoriable costs: Year 1: $1,400 ÷ 1,400 = $1.00 per unit; $1.00 × (1400 – 1000) Year 2: $1,200 ÷ 1,000 = $1.20 per unit $1.20 × (400 + 1,000 – 1,200)
3. 20062007Variable Costing: Operating income $400 $700 Ending inventory 200 100 Absorption Costing: Operating income $600 $640 Ending inventory 400 240 Fixed manuf. overhead • in beginning inventory 0 200 • in ending inventory 200 140 AbsorptioncostingoperatingincomeVariablecostingoperatingincome= Fixedmanuf. costsin endinginventoryFixedmanuf. costsin beginninginventoryYear 1: $600 – $400 = $0.50 × 400 $0 $200 = $200 Year 2: $640 – $700 = ($0.70 × 200) – ($0.50 × 400) –$60 = –$60The difference in reported operating income is due to the amount of fixed manufacturing overhead in the beginning and ending inventories. In Year 1, absorption costing has a higher operating income of $200 due to ending inventory having $200 more in fixed manufacturing overhead than does beginning inventory. In Year 2, variable costing has a higher operating income of $60 due to ending inventory under absorption costing having $60 less in fixed manufacturing overhead than does beginning inventory. 4. a. Absorption costing is more likely to lead to inventory build-ups than variable costing. Under absorption costing, operating income in a given accounting period is increased by inventory buildup, because some fixed manufacturing costs are accounted for as an asset (inventory) instead of as a cost of the period of production. b. Although variable costing will counteract undesirable inventory build-ups, other measures can be used without abandoning absorption costing. Examples include: (1)careful budgeting and inventory planning, (2)incorporating a carrying charge for inventory, (3)changing the period used to evaluate performance to be long-term, (4)including nonfinancial variables that measure inventory levels in performance evaluations.

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