The Grand Rapid Corporation has two identical divisions: Western and Northern. T

Question

The Grand Rapid Corporation has two identical divisions: Western and Northern. Their sales, production volume, and fixed manufacturing costs have been the same for both divisions for the last five years and are as follows:

Western uses absorption costing and Northern uses variable costing. Both use FIFO inventory methods. Variable manufacturing costs are $5 per unit. Both have identical selling prices and selling and administrative expenses. There were no Year 1 beginning inventories.

Determine the difference in profits for each division for Years 1 through 5. Explain why profits differ between the two divisions.

Year 1 Year 2 Year 3 Year 4 Year 5 Units Produced 50000 50000 50000 50000 50000 Units Sold 40000 45000 55000 50000 55000 Fixed MFG Costs 250000 250000 250000 250000 250000

Explanation / Answer

Year 1 Year 2 YEar3 YEar4 Year 5 Total Fixed Mnaufacturing cost 250000 250000 250000 250000 250000 Divide: Units produced 50000 50000 50000 50000 50000 Fixed H per unit 5 5 5.00 5 5 Increase/(Decrease) in Inventory 10,000 5,000 -5000.00 0 -5000 Therefore, Increase/(Decrease) in income of Wwestern 50000.00 25000.00 -25000.00 0.00 -25000.00 (as compared to Northern) Note: Inocme of Aabsorption costing increased from income under variable c costing when the inventory level increases and fixed OH defferred. When inventory level decreases the fixed oh released and hence, income under absorption costing is lower.

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