(Absorption costing versus variable costing) Indiana Metalworks builds camshafts for car manufacturers. Company sales have increased yearly as the company gains a reputation for reliable and quality products. The company manufactures dies to customer specifications and it uses a job order cost system. Factory overhead is applied to the jobs based on direct labor hours, using the absorption costing method. Under- or overapplied overhead is treated as an adjustment to Cost of Goods Sold. The company’s inventory balances and income statements for the last 2 years are presented below.

In 1997 and 1998, actual direct labor hours expended were 20,000 and 23,000, respectively. The cost of raw material put into production was $292,000 in 1997 and $370,000 in 1998. Actual fixed overhead was $37,400 for 1997 and $42,300 for 1998, and the planned direct labor rate was equal to the actual direct labor rate.
For both years, all of the reported administrative costs were fixed. The variable portion of the reported selling expenses result from a commission of 5 percent of sales revenue.

a. For the year ended December 31, 1998, prepare a revised income statement using the variable costing method.

b. Prepare a numerical reconciliation of the difference in operating income be¬ tween the 1998 absorption and variable costing statements.

c. Describe both the advantages and disadvantages of using variable costing.
(CMA adapted)LO1

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INVENTORY BALANCES 12/31/96 12/31/97 12/31/98 Raw material $22,000 $30,000 $10,000 Work in process Costs $40,000 $48,000 $64,000 Direct labor hours 1,335 1,600 2,100 Finished goods Costs $25,000 $18,000 $14,000 Direct labor hours 1,450 1,050 820 1997-1998 COMPARATIVE INCOME STATEMENTS 1997 1998