The Grand Rapid Corporation has two identical divisions West

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

Solution

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.