Question

Expected sales for next year for the Waterway Industries is 210000 units. Curt Planters, manager of the Waterway Division, is under pressure to improve the performance of the Division. As he plans for next year, he has to decide whether to produce 210000 units or 230000 units. The Waterway Industries will have higher net income if Curt Planters decides to produce

Answer 1

Under variable costing, fixed manufacturing cost is treated as period cost and expensed in the year in which it is incurred. Under absorption costing, fixed manufacturing overhead is treated as product cost. So, under absorption costing a part of fixed manufacturing overhead is transferred to the next period through ending inventory. So, under absorption costing if we produce 230,000 units and expected sales are 210,000 units, some of the fixed costs are transferred to next year through ending inventory of 20,000 units. Hence, net income will be higher if it produces 230,000 units if income is measured under absorption costing.