Reference no: EM132690764

To drive home your understanding of the difference between absorption costing (US GAAP) and variable costing and it's importance, please review the "Focus on Ethics: Incentive to Overproduce Inventory"

In summary, Brandolino Company operates a plant that can manufacture 40 million units. They use an actual-cost system to apply all production costs to units produced. In Year 1, they manufacture and sell 10 million units, and they report an $18 million operating loss on sales of $60 million. The stockholders are unhappy. The board of directors hires a consultant to run the company for no salary but 10% of pre-bonus operating income. The consultant promptly steps up production to an annual rate of 30 million units. Unit and dollar sales remain unchanged at 10 million units and $60 million, respectively. Selling and administrative expenses remain at their Year 1 level. Accounting practices remain unchanged. However, Year 2 operating income (before bonus) improves to $14 million. The consultant collects a $1.4 million bonus and resigns.

REQUIREMENTS: After reading the case and reviewing the Year 1 and Year 2 financial statements provided, click on the link above, then click on CREATE THREAD and post your responses answer the following questions.

Question a.) Using variable costing, what would operating income (pre-bonus) have been in Year 1 and Year 2? (Assume that selling and administrative expenses are unchanged.)

Question b.) Contrast your estimates of net operating income (pre-bonus) using variable costing with the absorption costing statements which were prepared in accordance with US GAAP which show a substantial improvement in operating income (pre-bonus). Why the difference? What happened to the costs?