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Income Statements with Absorption and Variable Costing Methods

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A single-product company prepares income statements using both absorption and variable costing methods. Manufacturing overhead cost applied per unit produced under absorption costing in year 2 was the same as in year 1. The year 2 variable costing statement reported a profit whereas the year 2 absorption costing statement reported a loss. The difference in reported income could be explained by units produced in year 2 being:

Less than units sold in year 2.
Less than the activity level used for allocating overhead to the product.
In excess of the activity level used for allocating overhead to the product.
In excess of units sold in year 2

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Solution Summary

This solution identifies the difference in reported income of the units produced in year 2 by explaining the concepts of inventory, variable costing, profit, absorption costing and total cost.

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The correct answer is the first one: the difference in reported income could be explained by units produced in year 2 being LESS than units sold in year 2.

If inventories are run down over a ...

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