Case 844 Absorption and Variable Costing; Effect on the Balance Sheet; Continuation of Preceding Case (LO 8-1, 8-4)

Refer to the information given in Case 842 for Lehighton Chalk Company. Selected information from Lehightons year-end balance sheets for its first two years of operation is as follows:

LEHIGHTON CHALK COMPANY Selected Balance Sheet Information
Based on absorption costing	End of Year 1	End of Year 2
Finished-goods inventory	$10,500	$ 0
Retained earnings	16,500	24,600
Based on variable costing	End of Year 1	End of Year 2
Finished-goods inventory	$ 3,500	$ 0
Retained earnings	9,500	24,600

Required:

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

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

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.

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.

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 companys reported operating income for year 2 under absorption versus variable costing. (Refer to the operating income statements prepared in Case 842.)

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.