Exercises 18-46 (Algo) Profit Centers: Comparison of Variable and Full Costing (Underapplied Overhead) [LO 18-3, 18-4] Mark Hancock Incorporated manufactures a specialized surgical instrument called the HAN-20. The firm has grown rapidly in recent years because of the products low price and high quality. However, sales have declined this year primarily due to increased competition and a decrease in the surgical procedures for which the HAN-20 is used. The firm is concerned about the decline in sales and has hired a consultant to analyze the firms profitability. The consultant was provided the following information: 2021 2022 Sales (units) 3,600 3,200 Production 4,120 2,720 Budgeted production and sales 4,400 3,800 Beginning inventory 800 1,320 Data per unit (all variable) Price $ 2,095 $ 1,995 Direct materials and labor 1,200 1,200 Selling costs 125 125 Fixed costs Manufacturing overhead $ 770,000 $ 665,000 Selling and administrative 120,000 120,000 Top management at Hancock explained to the consultant that a difficult business environment for the firm in 2021 and 2022 had caused the firm to reduce its price and production levels and reduce its fixed manufacturing costs in response to the decline in sales. Even with the price reduction, there was a decline in sales in both years. This led to an increase in inventory in 2021, which the firm was able to reduce in 2022 by further reducing the level of production. In both years, Hancocks actual production was less than the budgeted level so that the overhead rate for fixed overhead, calculated from budgeted production levels, was too low, and a production volume variance was calculated to adjust cost of goods sold for the underapplied fixed overhead (the calculation of the production volume variance is explained fully in Chapter 15 and reviewed briefly below). The production volume variance for 2021 was determined from the fixed overhead rate of $175 per unit ($770,000/4,400 budgeted units). Because the actual production level was 280 units short of the budgeted level in 2021 (4,400 4,120), the amount of the production volume variance in 2021 was 280 $175 = $49,000. The production volume variance is underapplied because the actual production level is less than budgeted, and the production volume variance is therefore added back to cost of goods sold to determine the amount of cost of goods sold in the full costing income statement. The full costng income statement for 2021 is shown below: Sales 7,542,000 Cost of goods sold: Beginning inventory $ 1,100,000 Cost of goods produced 5,665,000 Cost of goods available for sale $ 6,765,000 Less ending inventory 1,815,000 Cost of goods sold: $ 4,950,000 Plus unfavorable production volume variance 49,000 Adjusted cost of goods sold $ 4,999,000 Gross margin $ 2,543,000 Less selling and administrative costs Variable $ 450,000 Fixed 120,000 570,000 Operating income $ 1,973,000 Required: 1. Using the full costing method, prepare the income statement for 2022. 2-a. Using variable costing, prepare an income statement for each period. 2-b. Prepare a reconciliation of the difference each year in the operating income resulting from the full- and variable-costing methods