(Absorption costing versus variable costing) Riveting Manufacturing builds light aircraft engines and, since opening in 2005, has quickly gained a reputation for reliable and quality products. Factory overhead is applied to production using direct labor hours and any underapplied or overapplied overhead is closed at year-end to Cost of Goods Sold. The company’s inventory balances for the last three years and income statements for the last two years follow.

The same predetermined overhead rate was used in applying overhead to production orders in both 2006 and 2007. The rate was based on the follow¬ ing estimates:

In 2006 and 2007, actual direct labor hours expended were 20,000 and 23,000, respectively. The cost of raw material put into production was $292,000 in 2006 and $370,000 in 2007. Actual fixed overhead was $37,400 for 2006 and $42,300 for 2007, 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 results from a commission of 5 percent of sales revenue.

a. For the year ended December 31, 2007, prepare a revised income state¬ ment using the variable costing method.

b. Prepare a numerical reconciliation of the difference in operating income between the 2007 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 12/31/05 12/31/06 12/31/07 Direct 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 COMPARATIVE INCOME STATEMENTS Sales Cost of goods sold Finished goods, 1/1 $ 25,000 2006 $840,000 $ 18,000 2007 $1,015,000 Cost of goods manufactured 548,000 Total available $573,000 657,600 $675,600 Finished goods, 12/31 (18,000) (14,000) CGS before overhead adjustment $555,000 Underapplied factory overhead 36,000 Cost of goods sold (591,000) Gross margin $249,000 $661,600 14,400 (676,000) $ 339,000 Selling expenses $ 82,000 $ 95,000 Administrative expenses 70,000 75,000 Total operating expenses (152,000) Operating income $ 97,000 (170,000) $ 169,000