The New York Company has built a massive water-desalting factory next to an ocean. The factory is completely automated. It has its own source of power, light, heat, and so on. The salt water costs nothing. All producing and other operating costs are fixed; they do not vary with output because the volume is governed by adjusting a few dials on a control panel. The employees have flat annual salaries.

The desalted water is not sold to household consumers. It has a special taste that appeals to local breweries, distilleries, and soft-drink manufacturers. The price, $.66 per gallon, is expected to remain unchanged for quite some time.

The following are data regarding the first 2 years of operations:

Orders can be processed in 4 hours so management decided, in early 20X1, to gear production strictly to sales.

1. Prepare three-column income statements for 20X0, for 20X1, and for the 2 years together using (a) variable costing and (b) absorption costing.

2. What is the break-even point under (a) variable costing and (b) absorption costing?

3. What inventory costs would be carried on the balance sheets on December 31, 20X0 and 20X1, under each method?

4. Comment on your answers in numbers 1 and 2. Which costing method appears more useful?

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In Gallons Costs (All Fixed) Sales Production Manufacturing Other 20X0 1,700,000 3,400,0XX) $748,000 $225,000 20X1 1,700,000 748,000 225,000