Ruth Dennis, CEO of Prescott Industries, is concerned about the recent volatility in the company’s operating income. She believes that since the number of units sold has been fairly stable over the past three years that operating income also should have been stable. Ruth asked Jim Randall, Prescott’s inventory manager, to help her understand the issue.
Jim reviewed the company’s records and compiled the following changes to Finished Goods Inventory (in units) for the years 2019, 2020, and 2021.
Jim also gathered the 2019 income statements prepared using absorption costing and variable costing, which follow.
Required
a. Compute the unit product cost for 2019, 2020, and 2021 for variable and absorption costing. Assume costs do not change from one year to the next.
b. Prepare variable and absorption costing income statements for 2020 and 2021.
c. What do you notice about the trend in operating income from 2019 to 2021 under absorption costing? Compare this trend to the trend in unit sales.
d. Add the operating incomes across the three years for variable costing and absorption costing. What do you notice about the two totals? Why did this happen?
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