A company that produces a single product has a net operating income of $80,000 using variable costing and a net operating income of $104,750 using absorption costing. Total fixed manufacturing overhead was $53,550 and production was 10,500 units both this year and last year. Last year was the first year of operations. Between the beginning and the end of the year, the inventory level: (Do not round intermediate computation and round your final answer to nearest whole number.)

a. increased by 4,853 units

b. decreased by 4,853 units

c. increased by 24,750 units

d. decreased by 24.750 units

The correct option is A, increased by 4,853 units

Explanation:

The fact that profit under absorption costing is higher than profit under variable costing implies that some items of inventory under absorption costing had fixed cost included in them, which was expensed under variable costing method as period cost. In other words, closing inventory has increased.

The increase can be computed thus:

=absorption costing profit-variable costing profit/fixed cost per unit

fixed cost per unit=total fixed cost/units of output=$53,550/10,500=$5.1

increase in inventory = ($104,750-$80,000) / $5.1=4853 units

The difference between the two profits figure is the fixed cost added to closing inventory under absorption costing which makes the profit goes up.