Variable versus absorption costing The Zwatch Company manufactures trendy, high-quality moderately priced watches. As Zwatch’s senior financial analyst, you are asked to recommend a method of inventory costing. The CFO will use your recommendation to prepare Zwatch’s 2012 income statement. The following data are for the year ended December 31, 2012:

Beginning inventory, January 1, 2012 85,000 units

Ending inventory, December 31, 2012 34,500 units

2012 sales 345,400 units

Selling price (to distributor) $22.00 per unit

Variable manufacturing cost per unit, including direct materials $5.10 per unit

Variable operating (marketing) cost per unit sold $1.10 per unit sold

Fixed manufacturing costs $1,440,000

Denominator-level machine-hours 6,000

Standard production rate 50 units per machine-hour

Fixed operating (marketing) costs $1,080,000

Assume standard costs per unit are the same for units in beginning inventory and units produced during the year. Also, assume no price, spending, or efficiency variances. Any production-volume variance is written off to cost of goods sold in the month in which it occurs.

Required

1. Prepare income statements under variable and absorption costing for the year ended December 31, 2012.

2. What is Zwatch’s operating income as percentage of revenues under each costing method?

3. Explain the difference in operating income between the two methods.

4. Which costing method would you recommend to the CFO? Why?