For this discussion, compare and contrast Absorption Costing and Variable Costing. Identify the strengths and weaknesses of each approach and discuss how to mathematically reconcile the differences between the two approaches.

Lehighton Chalk Company manufactures sidewalk chalk, which it sells online by the box at $27 per unit. Lehighton uses an actual costing system, which means that the actual costs of direct material, direct labor, and manufacturing overhead are entered into work-in-process inventory. The actual application rate for manufacturing overhead is computed each year; actual manufacturing overhead is divided by actual production (in units) to compute the application rate. Information for Lehighton's first two years of operation is as follows:

Year 1Year 2

Sales (in units)3,0003,000

Production (in units)3,4002,600

Production costs:

Variable manufacturing costs.$18,360$14,040

Fixed manufacturing overhead22,44022,440

Selling and administrative costs:

Variable12,00012,000

Fixed11,00011,000

Selected information from Lehighton's year-end balance sheets for its first two years of operation is as follows:

LEHIGHTON CHALK COMPANY

Selected Balance Sheet Information

Based on absorption costingEnd of Year 1End of Year 2

Finished-goods inventory$4,800$0

Retained earnings16,50030,520

Based on variable costingEnd of Year 1End of Year 2

Finished-goods inventory$2,160$0

Retained earnings13,86030,520

Questions

Lehighton Chalk Company had no beginning or ending work-in-process inventories for either year.

1. Prepare operating income statements for both years based on absorption costing.
2. Prepare operating income statements for both years based on variable costing.
3. Prepare numerical reconciliation of the difference in income reported under the two costing methods used in requirements (1) and (2).