A company that produces a single product had a net operating income of $65,000 using variable costing and a net operating income of $95,000 using absorption costing.Total fixed manufacturing overhead was $60,000 and production was 10,000 units.This year was the first year of operations.Between the beginning and the end of the year, the inventory level:

A) decreased by 5,000 units
B) increased by 5,000 units
C) decreased by 30,000 units
D) increased by 30,000 units

Question

Taleisha Bozzi · Accepted Answer

Final Answer : B, Explanation :  The difference in net operating income between variable costing and absorption costing is due to the difference in accounting for fixed manufacturing overhead. Absorption costing includes all fixed manufacturing overhead as part of product cost, while variable costing only includes variable manufacturing costs as part of product cost. Therefore, when production exceeds sales, absorption costing will result in higher net operating income because some of the fixed manufacturing overhead cost is deferred into inventory.In this case, since net operating income is higher using absorption costing, we know that production exceeded sales. Therefore, inventory must have increased during the year. We can calculate the increase in inventory by finding the difference between production and sales:Production = 10,000 unitsSales = Production - Increase in inventory$95,000 - $65,000 = (10,000 units - Increase in inventory) X ($6 per unit fixed manufacturing overhead)$30,000 = Increase in inventory X $6Increase in inventory = 5,000 unitsTherefore, inventory increased by 5,000 units during the year.   *Plug figureFixed manufacturing overhead per unit = $60,000 ÷ 10,000 units = $6 per unitManufacturing overhead deferred in (released from)inventory = Fixed manufacturing overhead in ending inventory - Fixed manufacturing overhead in beginning inventory$30,000 = ($6 per unit × Units in ending inventory)- ($6 per unit × Units in beginning inventory)$30,000 = $6 per unit × (Units in ending inventory -Units in beginning inventory)(Units in ending inventory -Units in beginning inventory)= $30,000 ÷ $6 per unit = 5,000 units

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