Question

Exercise 6-3 (Algo) Reconciliation of Absorption and Variable Costing Net Operating Incomes [LO6-3]

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Jorgansen Lighting, Inc., manufactures heavy-duty street lighting systems for municipalities. The company uses variable costing for internal management reports and absorption costing for external reports to shareholders, creditors, and the government. The company has provided the following data:

	Year 1	Year 2	Year 3
Inventories
Beginning (units)	210	160	200
Ending (units)	160	200	230
Variable costing net operating income	$300,000	$279,000	$250,000

The company’s fixed manufacturing overhead per unit was constant at $550 for all three years.

rev: 03_09_2019_QC_CS-162392

Exercise 6-3 (Algo) Part 2

2. Assume in Year 4 that the company’s variable costing net operating income was $240,000 and its absorption costing net operating income was $280,000.

a. Did inventories increase or decrease during Year 4?

multiple choice

• Increase

• Decrease

b. How much fixed manufacturing overhead cost was deferred or released from inventory during Year 4?

Answer 1

a)Under absorption costing ,fixed manufacturing overhead cost is a part of product cost whereas under variable costing ,fixed manufacturing overhead cost is a period cost thus whole of the fixed overhead cost is charged to income statement in the period in which it is incurred.

The income under absorption costing ($ 280000) is greater than variable costing ($240000)thus it means some of the fixed manufacturing overhead cost is deferred in ending inventory resulting in higher net income under absorption costing.

Increase

b)Fixed manufacturing overhead cost deferred in ending inventory in year 4 =Income under absorption costing -Income under variable costing

         = 280000 -240000

        = 40000

b)