Problem: MedCo, Inc. manufactures a specialized breathing instrument called the MCB1000. The firm has grown rapidly in recent years because of the product's low price and high quality. However, sales have declined this year due to increased competition and a decrease in the surgical procedures for which the MCB1000 is used. The firm is concerned about the decline in sales, especially the decline in operating income over the past year. The firm has hired a consultant to analyze the firm's profitability. The consultant provided the following information:
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2004
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2005
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Units
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Sales (units)
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2,400
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1,900
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Production
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2,100
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1,500
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Budgeted production and sales
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1,875
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1,875
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Beginning inventory
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800
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500
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Data per unit (variable)
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Price
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$2,100
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$1,950
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Direct materials
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$ 460
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$ 460
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Direct labor
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$ 275
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$ 275
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Selling costs
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$ 125
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$ 125
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Period costs (fixed)
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Manufacturing overhead
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$450,000
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$450,000
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Selling and administrative
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$150,000
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$150,000
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Required:
Question 1: Using the full costing method, which MedCo's accountant used to prepare the annual financial statements, prepare the income statements for 2004 and 2005.
Question 2: Using variable costing, prepare an income statement for each period, and explain the difference in net income from that obtained in requirement 1.
Question 3: Write a brief explanation of the difference in income between variable costing and absorption costing.