The Rehe Company sells its razors at $3 per unit. The company uses a first-in, first-out actual costing system. A fixed manufacturing cost rate is computed at the end of each year by dividing the actual fixed manufacturing costs by the actual production units. The following data are related to its first two years of operation:

Required
1. Prepare income statements based on variable costing for each of the two years.
2. Prepare income statements based on absorption costing for each of the two years.
3. Prepare a numerical reconciliation and explanation of the difference between operating income for each year under absorption costing and variable costing.
4. Critics have claimed that a widely used accounting system has led to undesirable buildups of inventory levels, (a) Is variable costing or absorption costing more likely to lead to such buildups? Why? (b) What can be done to counteract undesirable inventory buildups?

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2007 1,200 units 1,000 units 2006 Sales Production Costs 1,000 units 1,400 units Variable manufacturing Fixed manufacturing Variable operating Fixed operating S 700 700 S 500 700 1,0001,200 400 400