Mega-Thirst produces an energy drink called Mega-Caffeine. The drinks sell to grocery stores and other retailers for $10 a case. During September, the first month of production, the company used $65,000 of aluminum cans and $35,000 of syrup, soda and caffeine. September manufacturing wages were $60,000 and variable manufacturing overhead incurred was $20,000. September's fixed manufacturing overhead costs were $70,000 and fixed selling and administrative costs were $12,000. Selling commissions were $0.25 per case. Mega-Thirst sold 46, 000 of the 50,000 cases that were produced in September for $10 per case.
- Which method would result in the larger operating income and why?

Question

Quizplus · Accepted Answer

Absorption costing results in a larger operating income when inventory levels increase, as it allocates a portion of fixed manufacturing overhead to the cost of each unit produced. This means that some of the fixed manufacturing overhead costs are included in the ending inventory value and not expensed in the period they are incurred, thus reducing the total expenses recognized in the period and increasing operating income. Since Mega-Thirst produced more than it sold, the ending inventory would include some of these fixed costs, leading to a higher operating income under absorption costing compared to variable costing, where all fixed manufacturing overhead costs are expensed in the period they are incurred.

Mega-Thirst Produces an Energy Drink Called Mega-Caffeine