(Comprehensive) Royals Fashions Company produces and sells cotton jerseys. The firm uses variable costing for internal purposes and absorption costing for external purposes. At year-end, financial information must be converted from variable costing to absorption costing to satisfy external requirements.

At the end of 2006, management anticipated that 2007 sales would be 20 percent above 2006 levels. Thus, production for 2007 was increased by 20 percent to meet the expected demand. Flowever, economic conditions in 2007 kept sales at the 2006 unit level of 40,000. The following data pertain to 2006 and 2007:

The overhead rate under absorption costing is based on an annual capacity of 60,000 units. Any volume variance is assigned to Cost of Goods Sold.
Taxes are to be ignored.

a. Present the income statement based on variable costing for 2007.

b. Present the income statement based on absorption costing for 2007.
C. Explain the difference, if any, in the income figures. Assuming that there is no work in process inventory, provide the entry necessary to adjust the book income amount to the financial statement income amount if an adjustment is necessary.

d. The company finds it worthwhile to develop its internal financial data on a variable costing basis. What advantages and disadvantages are at¬ tributed to variable costing for internal purposes?

e. Many accountants believe that variable costing is appropriate for external reporting; many others oppose its use for external reporting. List the ar¬ guments for and against the use of variable costing in external reporting.LO1.

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2006 2007 Selling price per unit $20 $20 Sales (units) 40,000 40,000 Beginning inventory (units) 4,000 4,000 Production (units) 40,000 48,000 Ending inventory (units) 4,000 ? Per-unit production costs (budgeted and actual) for 2006 and 2007 were: Material Labor Overhead Total $2.25 3.75 1.50 $7.50 Annual fixed costs for 2006 and 2007 (budgeted and actual) were Production Selling and administrative Total $117,000 125,000 $242,000