Question

At the end of the accounting period, Armstrong Corporation reports an operating income of $30,000. Which of the following statements is true, if Armstrong's inventory levels decrease during the accounting period?
A. Absorption costing will report less operating income than variable costing.
B. Variable costing will report less operating income than absorption costing.
C. Variable costing and absorption costing will report the same operating income since the total costs are the same.
D. Variable costing and absorption costing will report the same operating income since the cost of goods sold is the same.

Answer 1

Answer:

A) Absorption costing will report less operating income than variable costing.

Explanation:

When absorption costing is used by a company, all its manufacturing costs (direct labor, direct materials and variable overhead) have been absorbed by the units that have been manufactured.

If inventory levels decreased due to units that started being produced but are not completed, and if the company uses absorption costing, then the materials used for starting the manufacturing process will be assigned to the previously finished units.