Refer to the information given in Case 8-42 for Huron Chalk Company. Selected information from Huron’s year-end balance sheets for its first two years of operation is as follows:

In Case 8-42

HURON CHALK COMPANY
SELECTED BALANCE SHEET INFORMATION

Required: 

1. Why is the year 1 ending balance in finished-goods inventory higher if absorption costing is used than if variable costing is used?

2. Why is the year 2 ending balance in finished-goods inventory the same under absorption and variable costing?

3. Notice that the ending balance of finished-goods inventory under absorption costing is greater than or equal to the ending finished-goods inventory balance under variable costing for both years 1 and 2. Will this relationship always hold true at any balance sheet date? Explain.

4. Compute the amount by which the year-end balance in finished-goods inventory declined during year 2 (i.e., between December 31 of year 1 and December 31 of year 2):

• Using the data from the balance sheet prepared under absorption costing.
• Using the data from the balance sheet prepared under variable costing.

5. Refer to your calculations from requirement (4). Compute the difference in the amount by which the year-end balances in finished-goods inventory declined under absorption versus variable costing. Then compare the amount of this difference with the difference in the company’s reported operating income for year 2 under absorption versus variable costing. (Refer to the operating income statements prepared in Case 8–42.)

6. Notice that the retained earnings balance at the end of both years 1 and 2 on the balance sheet prepared under absorption costing is greater than or equal to the corresponding retained earnings balance on the statement prepared under variable costing. Will this relationship hold true at any balance sheet date? Explain.

Year 1 Sales (In units) Production (in units) Production costs: Year 2 2,500 2,000 2,500 3,000 $10,500 21,000 7,000 21,000 Variable manufacturing costs Fixed manufacturing overhead Selling and administrative expenses: Variable Fixed 12,500 10,000 12,500 10,000 Based on absorption costing Finished-goods inventory... Retained eamings. Based on varlable costing Finished-goods inventory. Retained eamings End of Year 1 Ed of Year 2 $5,250 8,250 End of Year 1 $1,750 4,750 12,300 End of Year 2 12,300 For convenience, assume that the company pays no taxes in Year 1 and Year 2, and operating income equals net income for computing of retained earnings