Question

. If the company produces 5,000 fewer units than it sells in its second year of operations, will absorption costing net operating income be higher or lower than variable costing net operating income in Year 2

Answer 1

Net Operating Income on Year 2 will be lower than Year 1. The reason is the distribution of fixed production cost under absorption costing

What is absorption costing?

Total absorption costing is an accounting cost method that includes the entire cost of manufacturing or providing a service. TAC includes not only material and labor costs, but also all manufacturing overheads. Each cost center's cost can be direct or indirect.

Insurance and rent are two examples. Absorption costing is an inventory valuation, which means it is a capitalized cost that is tracked on the balance sheet until the product is sold rather than a regular expense.

The finance manager can use the absorption costing formula (materials + labor + variable production overhead + fixed production overhead) (number of completed units) to estimate how much production expenses the company may incur.

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