Ting Ho Company began operations in January 20x2. All its costs are fixed; they do not vary with output.

Ting Ho Company is located in Science Park and has its own hydroelectric plant to supply power, light, and heat. The company manufactures a synthetic energy bar from air and river water and sells its product at a price that is not expected to change. It has a small staff of employees, all paid fixed annual salaries. The output of the plant can be increased or decreased by adjusting a few dials on a control panel.

The following budgeted and actual data are for the operations of Ting Ho Company. Ting Ho uses budgeted production as the denominator level and writes off any production-volume variance to cost of goods sold.

20x2 20x3

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Sales 10,000 tons 10,000 tons

Production 20,000 tons 0 tons

Selling price $25 per ton $25 per ton

Costs (all fixed):

Manufacturing $380,000 $380,000

Operating $35,000 $35,000

Required:

a) Prepare income statements with one column for 20x2, one column for 20x3, and one column for the two years together, using (a) variable costing and (b) absorption costing assuming a denominator level of 10,000 tons.

b) Determine the inventory costs that would be carried in the balance sheet on 31 December 20x2 and 20x3, under each method.

c) Assume that the performance of the top manager of the company is evaluated and rewarded largely on the basis of reported operating income. Which costing method would the manager prefer? Explain.