Question

The Grand Rapid Corporation has two identical divisions: Western and Northern. Their sales, production volume, and fixed manufacturing costs have been the same for both divisions for the last five years and are as follows:

	Year 1	Year 2	Year 3	Year 4	Year 5
Units Produced	50000	50000	50000	50000	50000
Units Sold	40000	45000	55000	50000	55000
Fixed MFG Costs	250000	250000	250000	250000	250000

Western uses absorption costing and Northern uses variable costing. Both use FIFO inventory methods. Variable manufacturing costs are $5 per unit. Both have identical selling prices and selling and administrative expenses. There were no Year 1 beginning inventories.

Determine the difference in profits for each division for Years 1 through 5. Explain why profits differ between the two divisions.

Answer 1

				Year 1	Year 2	YEar3	YEar4	Year 5
Total Fixed Mnaufacturing cost				250000	250000	250000	250000	250000
Divide: Units produced				50000	50000	50000	50000	50000
Fixed H per unit				5	5	5.00	5	5
Increase/(Decrease) in Inventory				10,000	5,000	-5000.00	0	-5000
Therefore,
Increase/(Decrease) in income of Wwestern				50000.00	25000.00	-25000.00	0.00	-25000.00
(as compared to Northern)
Note: Inocme of Aabsorption costing increased from income under variable c costing when the inventory level increases and fixed OH defferred.
When inventory level decreases the fixed oh released and hence, income under absorption costing is lower.