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In this week’s discussion, we will examine the effects of absorption costing and variable costing on...

In this week’s discussion, we will examine the effects of absorption costing and variable costing on net income.

Harris Company’s fixed overhead costs are $4 per unit, and its variable overhead costs are $8 per unit. In the first month of operations, 50,000 units are produced and 46,000 units are sold. Write a short memo to the chief operating officer explaining which costing approach will produce the higher income and what the difference will be.

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Answer #1

Fixed overhead costs are absorbed in the product under absorption costing while it is charged as a period cost under variable costing

Since the goods sold are lower than purchased, absorption costing approach will produce the higher income

As fixed overhead cost of 4,000 unsold units will be carried in inventory

i.e. difference in amount of profit under the two approaches = Ending Inventory*Fixed overhead cost per unit

= 4,000*4

= $16,000

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