MT Designs, Inc., manufactures a motorcycle accessory. The company was very successful in 2006 and demand for their product was much higher than anticipated. Use the following production and sales information to answer the questions.

Assume all fixed costs and all variable unit costs remained the same from the previous year.
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A. Prepare an income statement using variable costing.
B. Prepare an income statement using absorption costing.
C. Explain why net income is higher using variable costing than absorption costing.
D. Suppose that MT Designs was facing an extended slump in demand for its product, and that the production manager is evaluated based on net income. What would be a possible drawback to using absorption costing in this instance?

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Production Sales Selling price Direct materials used, 2004 5,000 units 9.000 units $220 $125,000 Direct labor cost, 2004 Variable manufacturing overhead, 2004 Fixed manufacturing overhead, 2004 Variable selling expenses $200,000 $25,000 $60,000 $90,000 Fixed administrative and selling expenses $130,000