The Zwatch Company manufactures trendy, high-quality moderately priced watches. As Zwatch's senior financial analyst, you are asked to recommend a method of inventory costing. The CFO will use your recommendation to prepare Zwatch's 2007 income statement. The following data are for the year ended December 31, 2007:
Beginning inventory, January 1, 2007 ........................... 85,000 units
Ending inventory, December 31,2007 ............................ 34,500 units
2007 sales ............................................................ 345,400 units
Selling price (to distributor) ....................................... $22.00 per unit
Variable manufacturing cost per unit,
including direct materials .......................................... $5.10 per unit
Variable operating cost per unit sold ............................. $1.10 per unit sold
Fixed manufacturing costs ......................................... $1,440,000
Denominator-level machine-hours ................................ 6,000
Standard production rate ........................................... 50 units per machine hour
Fixed operating costs ................................................ $1,080,000
Assume standard costs per unit are the same for units in beginning inventory and units produced during the year. Also, assume no price, spending, or efficiency variances. Any production-volume variance is written off to cost of goods sold in the month in which it occurs.
Required
1. Prepare income statements under variable and absorption costing for the year ended December 31,2007.
2. What is Zwatch's operating income as percentage of revenues under each costing method?
3. Explain the difference in operating income between the two methods.
4. Which costing method would you recommend to the CFO? Why?