EXERCISE 7-9 (20 MINUTES)

1. Absorption costing, which includes both fixed and variable manufactur-

ing costs in the product cost, is widely considered to be required on ex-

ternal financial reports in the United States.

2 A company with sales below the break-even point may be able to report

a profit if its inventories increase. Break-even points are computed as-

suming that fixed costs are expensed in the year in which they are in-

curred. However, if production exceeds sales and the company uses ab-

sorption costing, then a portion of the fixed manufacturing costs will be

included as part of ending inventories on the balance sheet rather than

being expensed on the income statement.