Absorption costing and production-volume variance-alternative capacity bases. Earth Light First (ELF), a producer of energy-efficient light bulbs, expects that demand will increase markedly over the next decade. Due to the high fixed costs involved in the business, ELF has decided to evaluate its financial performance using absorption costing income. The production-volume variance is written off to cost of goods sold. The variable cost of production is $2.50 per bulb. Fixed manufacturing costs are $1,000,000 per year. Variable and fixed selling and administrative expenses are $0.25 per bulb sold and $250,000, respectively. Because its light bulbs are currently popular with environmentally-conscious customers, ELF can sell the bulbs for $9.00 each.

ELF is deciding whether to use, when calculating the cost of each unit produced:

1. Calculate the inventoriable cost per unit using each level of capacity to compute fixed manufacturing cost per unit.

2. Calculate the production-volume variance using each level of capacity to compute the fixed manufacturing overhead allocation rate and this year’s production of 220,000 bulbs.

3. Assuming ELF has no beginning inventory, calculate operating income for ELF using each type of capacity to compute fixed manufacturing cost per unit and this year’s sales of 200,000 bulbs.

Theoretical capacity 800,000 bulbs Practical capacity 500,000 bulbs 250,000 bulbs (average production for the next three years) 200,000 bulbs produced this year Normal capacity Master budget capacity