Question

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)	220	150	190
Ending (units)	150	190	230
Variable costing net operating income	$290,000	$269,000	$260,000

The company’s fixed manufacturing overhead per unit was constant at $570 for all three years.

rev: 03_09_2019_QC_CS-162392

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 $270,000.

a. Did inventories increase or decrease during Year 4?

• Increase

• Decrease

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

Answer 1

2-a) The net income under absorption costing is greater than the net income under variable costing that means the inventories increase during the year as the difference in the net income under absorption costing and variable costing arises due to the fixed manufacturing overhead. In variable costing all the fixed manufacturing is taken while in absorption costing fixed manufacturing overhead is calculated on the basis of the number of units sold and in this case the net income under absorption costing is greater than net income under variable costing which means the number of units sold must be less than the units produced.

So, the answer is option A) Increases

b) As the net income under absorption costing is greater than variable costing that means the fixed manufactuting overhead must be deferred in inventory

Net income under absorption costing= Net income under variable costing+Fixed manufacturing overhead cost deferred in inventory

$270000= $240000+Fixed manufacturing overhead cost deferred in inventory

Fixed manufacturing overhead cost deferred in inventory= $30000