Ruth Dennis, CEO of Prescott Industries, is concerned about the recent volatility in the company's operating income. She believes that since the number of units sold has been fairly stable over the past three years that operating income also should have been stable. Ruth asked Jim Randall, Prescott's inventory manager, to help her understand the issue.

Jim reviewed the company's records and compiled the following changes to Finished Goods Inventory (in units) for the years 2013, 2014, and 2015.

Jim also gathered the 2013 income statements prepared using absorption costing and variable costing, which follow.

Required
a. Compute the unit product cost for 2013, 2014, and 2015 for variable and absorption costing. Assume costs do not change from one year to the next.
b. Prepare variable and absorption costing income statements for 2014 and 2015.
c. What do you notice about the trend in operating income from 2013 to 2015 under absorption costing? Compare this trend to the trend in unit sales.
d. Add the operating incomes across the three years for variable costing and absorption costing. What do you notice about the two totals? Why did thishappen?

Transcribed Image Text:

Year 2014 2,000 38,000 (39,000) (39,500) (9,500) 2015 500 40,000 2013 Beginning inventory 1,000 Production Sales 40,000 Ending inventory 2000 500 1,000 Income Statement-Absorption Costing Sales Cost of goods sold $ 4,290,000 Units in beginning inventory (90,000) (3,420,000) (3,510,000) 780,000 (645,000) S 135,000 Units sold from current year production Total cost of goods sold Gross margin Selling expense Operating Income Income Statement-Variable Costing Sales Variable production expenses Variable selling expenses Contribution margin Fixed manufacturing expenses Fixed selling expenses Operating income $ 4,290,000 (2,028,000) (195,000) 2,067,000 (1,520,000) (450,000) $ 97,000