Problem:
Mix-a-lot Co. is a division of a Mixer Corporation, large diversified chemical company provides mixing services for both outside customers and other divisions. Mix-a-lot buys or receives liquid chemicals and combines and packages them according to the customer's specifications. Mix-a-lot computes its divisional net income on both a fully absorbed and variable costing basis. For the year just ending, it reported:
Absorption costing $13,800,000
Variable costing 12,600,000
Difference $1,200,000
Overhead is assigned to products using machine hours. There is no finished goods inventory at Mix-a-lot, only work-in-process (WIP) inventory. As soon as a product is completed, it is shipped to the customer. The beginning inventory was valued at $6.3 million and contained 70,000 machine hours. The ending WIP inventory was valued at $9.9 million and contained 90,000 machine hours.
Required:
Write a short, nontechnical note to senior management explaining why variable costing and absorption costing net income amounts differ. Also, show your accounting data reflect your calculations which support your answer. Be detailed but use "laymans" terms for best understanding.