A manufacturer reports the information below for three recent years. Year 1 Year 2 Year 3 Variable costing income $ 120,500 $ 125,600 $ 127,700 Beginning finished goods inventory (units) 0 1,550 1,050 Ending finished goods inventory (units) 1,550 1,050 1,150 Fixed manufacturing overhead per unit $ 3.80 $ 3.80 $ 3.80 Compute income for each of the three years using absorption costing.

Absorption income 114, 610 127,500 127,320

Explanation:

Year 1 Year 2 Year 3

Beginning finished

Goods inventory (units) 0 1,550 1,050

Ending finished

Goods inventory (units) 1,550 1,050 1,150

Change in Inventory 1550 500 100

Fixed manufacturing

Overhead per unit $ 3.80 $ 3.80 $ 3.80

Absorption Income Less

Variable Income $ 5890 ($ 1900) $ 380

Variable costing income $ 120,500 $ 125,600 $ 127,700

Difference $ 5890 ($ 1900) $ 380

Absorption income 114, 610 127,500 127,320

When inventory increases or decreases income differs under absorption and variable costing and is calculated by the following formula

Difference in fixed expense overhead expensed under absorption and variable costing = Change in inventory units * Predetermined overhead rate

When the inventory units increase the fixed manufacturing overhead cost is released from inventory and deducted from variable income.

Similarly when the inventory units decrease the the fixed manufacturing overhead cost is deferred from inventory and added to variable income.