Question

Diego Company manufactures one product that is sold for $78 per unit in two geographic regions—the East and West regions. The following information pertains to the company’s first year of operations in which it produced 49,000 units and sold 44,000 units.

Variable costs per unit:
Manufacturing:
Direct materials	$	28
Direct labor	$	14
Variable manufacturing overhead	$	4
Variable selling and administrative	$	6
Fixed costs per year:
Fixed manufacturing overhead	$	686,000
Fixed selling and administrative expense	$	510,000

The company sold 32,000 units in the East region and 12,000 units in the West region. It determined that $230,000 of its fixed selling and administrative expense is traceable to the West region, $180,000 is traceable to the East region, and the remaining $100,000 is a common fixed expense. The company will continue to incur the total amount of its fixed manufacturing overhead costs as long as it continues to produce any amount of its only product.

12. If the company produces 5,000 fewer units than it sells in its second year of operations, will absorption costing net operating income be higher or lower than variable costing net operating income in Year 2?

• Lower

• Higher

Answer 1

Lower, the absorption costing net operating income will be lower than variable costing net operating income in Year 2

When sales exceeds production, absorption costing net operating income is lower than variable costing net operating income.

The fixed manufacturing overhead under absorption costing from beginning inventory is released which lowers absorption costing net operating income