401. All of the manufacturing costs flow through the absorption costing cost of goods sold and all of the selling and administrative expenses are listed separately as period expenses.402. In general, when the units produced exceed the units sold and hence inventories increase, net operating income is higher under absorption costing than under variable costing.403. In contrast, when the units sold exceed the units produced and hence inventories decrease, net operating income is lower under absorption costing than under variable costing.404. This occurs because some of the fixed manufacturing overhead of previous periods is released from inventories under absorption costing.405. When the units produced and the units sold are equal, no change in inventories occurs and absorption costing and variable costing net operating incomes are the same.406. Variable costing and absorption costing net operating incomes can be reconciled by determining how much fixed manufacturing overhead was deferred in, or released from, inventories during the period.407. Changes in inventories affect absorption costing net operating income—they do not affect variable costing net operating income, providing that variable manufacturing costs per unit are stable.408. Under variable costing, just the fixed manufacturing overhead of the current period flows through to the income statement.409. Because variable costing income statements categorize costs as variable and fixed, it is much easier to use this income statement format to perform CVP analysis than attempting to use the absorption costing format, which mixes together variable and fixed costs.410. In March, inventories decreased, so some of the fixed manufacturing overhead that had been deferred in February’s ending inventories was released to the March income statement, resulting in a net operating income that is $35,000 lower than the $235,000 predicted by CVP analysis.411. In fact, it was simply because the number of units produced exceeded the number of units sold in February and so some of the fixed manufacturing overhead costs were deferred in inventories in that month.412. These costs have not gone away—they will eventually flow through to the income statement in a later period when inventories go down.413. Under absorption costing, if inventories increase, fixed manufacturing overhead costs are deferred in inventories, which in turn increases net operating income.414. If inventories decrease, fixed manufacturing overhead costs are released from inventories, which in turn decreases net operating income.415. Thus, when absorption costing is used, fluctuations in net operating income can be caused by changes in inventories as well as changes in unit sales.416. The variable costing method correctly identifies the additional variable costs that will be incurred to make one more unit.417. The total amount of fixed manufacturing costs appears explicitly on the income statement, highlighting that the whole amount of fixed manufacturing costs must be covered for the company to be truly profitable.418. Under absorption costing, fixed manufacturing overhead costs appear to be variable with respect to the number of units sold, but they are not.419. Misinterpreting absorption unit product costs as variable can lead to many problems, including inappropriate pricing decisions and decisions to drop products that are in fact profitable.420. These segmented income statements are useful for analyzing the profitability of segments, making decisions, and measuring the performance of segment managers.
