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Operating income is $100,000 under variable costing and $137,500 under absorption costing when 20,000 units are produced and 15,000 sold. What causes the $37,500 gap?
AVariable selling costs deferred on 5,000 unsold units
BFixed selling costs deferred on 5,000 unsold units
CFixed factory overhead of $7.50 held on 5,000 units
DVariable factory cost of $25 held on 5,000 units
Answer & Solution
Correct answer: C. Fixed factory overhead of $7.50 held on 5,000 units
1. Variable costing charges the whole $150,000 of fixed factory overhead against the period.
2. Absorption costing charges only $7.50 per unit on the 15,000 units sold, which is $112,500.
3. The difference of $150,000 minus $112,500 is $37,500 still sitting in closing inventory.
4. That $37,500 is $7.50 per unit on the 5,000 units produced but not sold.
5. Deferring cost into inventory reduces this period's expense, so absorption income is higher by exactly that amount.
6. Variable factory cost of $25 is deferred under both methods, so it cannot explain a difference between them.
7. Selling costs never enter inventory under either method.
_Source: Jonick, Principles of Managerial Accounting (UNG Press, CC BY-SA 4.0), section 6.5 Analysis of Variable and Absorption Costing_
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