DigIT, a new manufacturer in 2020, produces and sells high tech earth moving machines. DigIT’s 2020 variable costing income statement is provided below. In 2020, DigIT produced 5,000 units and sold 4,000 units. During 2020 they had $15 million of Fixed Manufacturing Overhead cost, $13.2 million of Fixed Selling and Administrative cost, variable production costs (Direct Materials, Direct Labor, and Variable Manufacturing Overhead) of $8000 per unit produced, and Variable Selling and Administrative costs of $1000 per unit sold.

2020

Sales $80,000,000

-Variable Cost of Goods Sold $32,000,000

-Variable Selling and Admin. $4,000,000

Total Contribution Margin $44,000,000

-Fixed Manufacturing Overhead $15,000,000

-Fixed Selling and Administrative $13,200,000

Operating Income (Loss) $15,800,000

Required:

1. Assume that DigIT used Variable Costing and a last-in, first-out (LIFO) inventory cost flow assumption in 2021, as they did in 2020. Assume also that DigIT had the same cost structure in 2021 as in 2020, but in 2021 they produced only 3000 units and sold 4000 units.

a. Compute the product cost per unit produced for DigIT in 2020 and 2021.

b. Prepare a variable costing income statement for 2021.

2. Assume, just for this problem, that DigIT used Absorption Costing and a last-in, first-out (LIFO) inventory cost flow assumption in 2020.

a. Compute the product cost per unit produced in 2020.

b. Prepare an absorption costing income statement for 2020.

3. Reconcile the 2020 operating income values between variable (see given information above) costing and absorption (see your answer to question 2b) costing using the following formula: FMOH in ending inventory under absorption costing – FMOH in beginning inventory under absorption costing = absorption costing operating income - variable costing operating income. Note that a little rounding error (should be less than a few dollars) is ok.

4. Assume that DigIT had the same cost structure in 2021 as in 2020, but in 2021 they produced only 3000 units and sold 4000 units. Without performing any calculations, state whether 2021 absorption costing operating income will be higher, lower, or the same as the variable costing operating income level in 2021 (see answer to question 1b), and thoroughly explain why.

5. Are lower level managers incentivized to overproduce when they’re evaluated using their absorption costing operating income? Thoroughly explain why or why not?