Question

Smith Industries is a manufacturer whose absorption costing income statement reported sales of $28 million and...

Smith Industries is a manufacturer whose absorption costing income statement reported sales of $28 million and a net operating loss of $2.5 million for the year. According to a CVP model, Smith’s break-even point is $24 million in sales. Assuming the CVP model is correct, what most likely happened to inventory levels during the year?

1.Decreased

2.Remained the same

3.Increased

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Answer #1

As per Variable costing, Break Even Sales is $ 24 million.

As per Absorption costing, despite the Sales is $ 28 million we have Net Loss of $ 2.5 million.

As per absorption costing, when inventory levels fall, it is implied that the sale of units is greater than that produced. Thus, fixed cost element under absorption costing is higher than the fixed cost under variable costing. Thus we incurr losses.

Hence the Inventory levels have fallen in the given case. So Option 1 is correct.

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