Comparison of actual costing methods. The Rehe Company sells its razors at $3.60 per unit.

The company uses a first-in, first-out actual costing system. A new fixed manufacturing over¬

head allocation rate is computed each year by dividing the actual fixed manufacturing overhead cost by the actual production units. The following simplified data are related to its first two years of operation:

Year 1 Year 2 Unit data:

Sales 1,000 1,200 Production 1,400 1,000 Cost:
Variable manufacturing $ 840 $ 600 Fixed manufacturing 700 700 Variable marketing and administration 1,000 1,200 Fixed marketing and administration 400 400 Required 1. Prepare income statements based on

(a) variable costing and

(b) absorption costing for each year.
2. Prepare a reconciliation and explanation of the difference in the operating income for each year resulting from the use of absorption costing and variable costing.
3. Critics have claimed that a widely used accounting system has led to undesirable buildups of inventory levels.

a. Is variable costing or absorption costing more likely to lead to such buildups? Why?

b. What can be done to counteract undesirable inventory buildups?