Last year, Craft Company had a net operating income of £80,000 using absorption costing and £74,500 using variable costing. The fixed manufacturing overhead cost has been £5 per unit for the last three years. If 21,500 units were produced last year, then sales last year were
A)16,000 units.
B)20,400 units.
C)22,600 units.
D)27,000 units.

Question

Quizplus · Accepted Answer

The difference between absorption costing and variable costing incomes is due to the treatment of fixed manufacturing overhead. Under absorption costing, fixed manufacturing overhead is allocated to each unit produced, so when more units are produced than sold, some of the fixed overhead is included in the ending inventory and not expensed in the period. The difference in income (£80,000 - £74,500 = £5,500) represents the fixed overhead deferred in inventory under absorption costing. Since the fixed overhead rate is £5 per unit, the difference in income suggests that 1,100 units (5,500 / 5) were produced but not sold. Therefore, if 21,500 units were produced and 1,100 units were not sold, then 20,400 units (21,500 - 1,100) were sold.

Last Year, Craft Company Had a Net Operating Income of £80,000