Covington Company makes leather chairs that it sells for $500 per chair. Each chair requires $72 of direct materials and $170 of direct labor. Fixed overhead costs are expected to be $300,000 per year. Covington expects to sell 1,500 chairs during the coming year. Selling and administrative expenses were zero.
Required
a. Prepare income statements using absorption costing, assuming that Covington makes 1,500, 2,000, and 2,500 chairs during the year.
b. Prepare income statements using variable costing, assuming that Covington makes 1,500, 2,000, and 2,500 chairs during the year.
c. Explain why Covington may produce income statements under both absorption and variable costing formats. Your answer should include an explanation of the advantages or disadvantages associated with the use of the two reporting formats.