Sparn Limited incurs the following costs to produce and sell a single product:
Variable costs per unit:
Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10
Direct labour. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Variable manufacturing overhead . . . . . . . . . . . . . . . . . . . . . . 2
Variable selling and administrative expenses . . . . . . . . . . . . 4
Fixed costs per year:
Fixed manufacturing overhead . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000
Fixed selling and administrative expenses. . . . . . . . . . . . . . . 300,000
During the last year, 30,000 units were produced and 25,000 units were sold. The Finished Goods Inventory account at the end of the year shows a balance of $85,000 for the 5,000 unsold units.
Required:
1. Is the company using absorption costing or variable costing to cost units in the Finished Goods Inventory account? Show computations to support your answer.
2. Assume that the company wishes to prepare financial statements for the year to issue to its shareholders.
a. Is the $85,000 figure for finished goods inventory the correct amount to use on these statements for external reporting purposes? Explain.
b. At what dollar amount should the 5,000 units be carried in inventory for external reporting purposes?