12. If the company produces 4,000 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?
12. If the company produces 4,000 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?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Question
![### Diego Company Case Study
**Scenario Overview:**
Diego Company manufactures one product sold at $75 per unit in two geographic regions: the East and West. The following data pertains to the company's first year of operations, during which it produced 46,000 units and sold 42,000 units.
**Variable Costs per Unit:**
- Manufacturing:
- Direct materials: $25
- Direct labor: $20
- Variable manufacturing overhead: $2
- Variable selling and administrative: $4
**Fixed Costs per Year:**
- Fixed manufacturing overhead: $644,000
- Fixed selling and administrative expense: $388,000
The company sold 31,000 units in the East region and 11,000 units in the West region. It was determined that $200,000 of its fixed selling and administrative expense is traceable to the West region, $150,000 is traceable to the East region, with the remaining $38,000 as a common fixed expense. The company will continue to incur the total amount of its fixed manufacturing overhead costs as it continues to produce any amount of its only product.
**Question 12:**
If the company produces 4,000 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?
- [ ] Higher
- [ ] Lower
### Explanation:
Absorption costing includes all fixed manufacturing overhead costs as product costs, leading to higher operating income when inventory decreases (more units are sold than produced). This is because some of the fixed manufacturing costs are included in the cost of goods sold. In contrast, variable costing considers fixed manufacturing overhead as a period expense, impacting operating income differently depending on production and sales levels.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F4119fedc-b5ba-442d-99f8-6b329401f211%2F9d464a32-4785-4bd3-9112-ba5839b819b4%2F7k7uip74_processed.jpeg&w=3840&q=75)
Transcribed Image Text:### Diego Company Case Study
**Scenario Overview:**
Diego Company manufactures one product sold at $75 per unit in two geographic regions: the East and West. The following data pertains to the company's first year of operations, during which it produced 46,000 units and sold 42,000 units.
**Variable Costs per Unit:**
- Manufacturing:
- Direct materials: $25
- Direct labor: $20
- Variable manufacturing overhead: $2
- Variable selling and administrative: $4
**Fixed Costs per Year:**
- Fixed manufacturing overhead: $644,000
- Fixed selling and administrative expense: $388,000
The company sold 31,000 units in the East region and 11,000 units in the West region. It was determined that $200,000 of its fixed selling and administrative expense is traceable to the West region, $150,000 is traceable to the East region, with the remaining $38,000 as a common fixed expense. The company will continue to incur the total amount of its fixed manufacturing overhead costs as it continues to produce any amount of its only product.
**Question 12:**
If the company produces 4,000 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?
- [ ] Higher
- [ ] Lower
### Explanation:
Absorption costing includes all fixed manufacturing overhead costs as product costs, leading to higher operating income when inventory decreases (more units are sold than produced). This is because some of the fixed manufacturing costs are included in the cost of goods sold. In contrast, variable costing considers fixed manufacturing overhead as a period expense, impacting operating income differently depending on production and sales levels.
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