Cutterski Corporation manufactures a propeller. Shown below is Cutterski's cost structure: In its first year of operations, Cutterski produced 60,000 propellers but only sold 54,000. Which costing method (variable or absorption) will generate a higher net operating income in Cutterski's first year of operations and by how much?

Question

Cutterski Corporation manufactures a propeller. Shown below is Cutterski's cost structure:  In its first year of operations, Cutterski produced 60,000 propellers but only sold 54,000. Which costing method (variable or absorption) will generate a higher net operating income in Cutterski's first year of operations and by how much?

Quizplus · Accepted Answer

Absorption costing will generate a higher net operating income in Cutterski's first year of operations by $81,000. This is because absorption costing includes fixed manufacturing overhead costs in the cost of the product, whereas variable costing only includes variable costs. Since Cutterski produced 60,000 propellers but only sold 54,000, there will be a portion of fixed manufacturing overhead costs that are included in ending inventory under absorption costing. This increases the value of ending inventory and, therefore, decreases the cost of goods sold and increases net operating income. Under variable costing, fixed manufacturing overhead costs are expensed in the period incurred, regardless of the level of production.

Cutterski Corporation Manufactures a Propeller