Ben and Chris have been lifelong friends. They are engineer-minded and have always dreamed of starting a manufacturing company. They want to manufacture tires, but realize that this industry is heavily regulated and that achieving profitable operations will require skillful management. Despite the odds, they form Smooth Ride, Inc., and resolve to only stay in business if they report a positive net income after the company’s first year of operations. At the end of 2019, its first year of operations, Smooth Ride reported the following summarized data:

Sales (105,000 tires) $13,125,000 Production Costs (120,000 tires) Direct Materials $ 4,750,000 Direct Labor $ 3,675,000 Manufacturing Overhead: Variable $ 2,300,000 Fixed $ 950,000 Operating Expenses: Variable $ 1,050,000

Fixed $ 800,000 Depreciation on machinery $ 455,000 Property taxes $ 330,000 Personnel department expenses $ 140,000

Note: the last 3 expenses listed have already been included under either manufacturing overhead or operating expenses in the summarized data.

Required:

1. Before drawing up any financial statements, calculate by exactly how much Net Income will differ under Absorption Costing and Variable Costing. Which Method should result in the highest net income for 2019?

2. Prepare an income statement based on full absorption costing and based on variable costing. Based on the reported incomes using these methods, did Smooth Ride exceed the expectations of Ben and Chris?

3. Smooth Ride follows Generally Accepted Accounting Principles. Which method, full absorption or variable costing, will the company use to report its net income?