Comparison ofvariable costing and absorption costing. Consider the following data:

Hinkle Company Income Statement for the Year Ended December 31,2007 Variable Costing Absorption Costing Revenues $8,400,000 $8,400,000 Costs of goods sold (at standard) 4,392,000 5,490,000 Fixed manufacturing overhead 1,200,000 —

Manufacturing variances (all unfavourable):

Direct materials price and efficiency 60,000 60,000 Direct manufacturing labour price and efficiency 72,000 72,000 Variable manufacturing overhead spending and efficiency 36,000 36,000 Fixed manufacturing overhead:

Spending 120,000 120,000 Production volume — 480,000 Total marketing costs (all fixed) 1,200,000 1,200,000 Total administrative costs (all fixed) 600,000 600,000 Total costs 7,680,000 8,058,000 Operating income $ 720,000 $ 342,000 The inventories, carried at standard costs, were Variable Absorption Costing Costing December 31, 2006 $1,584,000 $1,980,000 December 31, 2007 72,000 90,000 Required 1. Tim Hinkle, president of the Hinkle Company, has asked you to explain why the operating income for 2007 is less than for 2006, even though sales have increased 40% over last year.

What will you tell him?

2. At what percentage of denominator level was the plant operating during 2007?

3. Prepare a numerical reconciliation and explanation of the difference between the operat¬

ing incomes under absorption costing and variable costing.

4. Critics have claimed that a widely used accounting system has led to undesirable buildups ofinventory 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?