Exeter Mfg. Co. introduced a new mass-produced specialty product early in the year. Production and sales of this product for the first four months are as follows: Month Units Produced Units Sold
1 800 600
2 1,100 800
3 1,200 1,100
4 1,000 1,400
The firm's budgeted fixed overhead is $200,000, and budgeted output is 1,000 units per month. The volume variance, if any, is carried forward month-by-month and closed at the end of the year. When 1,000 units are produced and sold, expected monthly operating income is $40,000.
Compared to using absorption costing, using variable costing will result in operating income for the 4-month period to be:

Question

Quizplus · Accepted Answer

Under absorption costing, all manufacturing costs including fixed manufacturing overheads are allocated to products. Variable costing, on the other hand, only includes variable costs such as direct materials, direct labor, and variable overheads in product costs. Fixed overhead costs are treated as period expenses and are not included in the product costs.

Given that the actual units produced and sold exceed the budgeted units, there will be a favorable volume variance under absorption costing. As a result, more fixed overheads will be allocated to the products, leading to a higher operating income under absorption costing.

Under variable costing, however, the volume variance is not reflected in the product costs. Since the fixed overheads are treated as period expenses, the operating income will be lower under variable costing compared to absorption costing. Therefore, the answer is B (lower).