Question

The Zwatch Company manufactures trendy, high quality, moderately pricedwatches.
As Zwatch’s senior financial analyst, you are asked to recommend a methodof inventory costing.
The CFO will use your recommendation to prepare Zwatch’s 2019 income statement.
The following data are for the year ended December 31, 2019:

Beginning inventory, January 1, 2019 100,000 units
Ending inventory, December 31, 2019 50,000 units
2019 sales 400,000 units
Selling price (to distributor) $25 per unit
Variable manufacturing cost per unit, including direct materials $6 per unit
Variable operating (marketing) cost per unit sold $2 per unit sold
Fixed manufacturing costs $1,625,000
Denominator-level machine-hours 6,500
Standard production rate 50 units per machine-hour
Fixed operating (marketing) costs $1,100,000
Assume standard costs per unit are the same for units in beginning inventory and unitsproduced during the year.
Also, assume no price, spending, or efficiency variances. Anyproduction-volume variance is written off to cost of goods sold in the month in which itoccurs.

1. Prepare income statements under variable and absorption costing forthe year ended December 31, 2019.
2. What is Zwatch’s operating income as percentage of revenues under eachcosting method?
3. Explain the difference in operating income between the two methods.
4. Which costing method would you recommend to the CFO? Why?

Answer 1