When production exceeds sales and the company uses the LIFO inventory flow assumption, the net operating income reported under absorption costing generally will be:
A)less than net operating income reported under variable costing.
B)greater than net operating income reported under variable costing.
C)equal to net operating income reported under variable costing.
D)higher or lower because no generalization can be made.

Question

Quizplus · Accepted Answer

When production exceeds sales, inventory levels increase. Under absorption costing, all manufacturing costs, including fixed overhead costs, are included in the cost of inventory. As a result, a larger portion of fixed overhead costs is allocated to the inventory and carried forward as an asset. However, under variable costing, fixed overhead costs are expensed immediately and are not included in the cost of inventory. Therefore, if production exceeds sales, absorption costing will report a higher net operating income compared to variable costing since more fixed overhead costs will be carried forward as assets.

When Production Exceeds Sales and the Company Uses the LIFO