1. a. By assumption, the unit selling price, unit variable costs, and total
fixed costs are constant from year to year. Consequently, variable
costing net operating income will vary with sales. If sales increase,
variable costing net operating income will increase. If sales decrease,
variable costing net operating income will decrease. If sales are con-
stant, variable costing net operating income will be constant. Since
variable costing net operating income was $510,600 each year, unit
sales must have been the same in each year.
The same is not true of absorption costing net operating income.
Sales and absorption costing net operating income do not necessarily
move in the same direction since changes in inventories also affect
absorption costing net operating income.
b. When variable costing net operating income exceeds absorption cost-
ing net operating income, sales exceed production. Inventories shrink
and fixed manufacturing overhead costs are released from invento-
ries. In contrast, when variable costing net operating income is less
than absorption costing net operating income, production exceeds
sales. Inventories grow and fixed manufacturing overhead costs are
deferred in inventories. The year-by-year effects are shown below.
Year 1 Year 2 Year 3 Year 4
Variable
costing NOI
> Absorption
< Absorption
Production >
Sales Production >
Sales Production <
Sales
Inventories
grow Inventories
shrink Inventories
shrink
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