Question: Denominator-level choices, changes in inventory levels, effect on operating income. Magic Me is a manufacturer of magic kits. It uses absorption costing based on standard costs and reports the following data for 2017:

There are no price, spending, or efficiency variances. Actual operating costs equal budgeted operating costs. The production-volume variance is written off to cost of goods sold. For each choice of denominator level, the budgeted production cost per unit is also the cost per unit of beginning inventory.

1. What is the production-volume variance in 2017 when the denominator level is

(a) theoretical capacity,

(b) practical capacity, and

(c) normal capacity utilization?

2. Prepare absorption costing-based income statements for Magic Me Corporation using theoretical capacity, practical capacity, and normal capacity utilization as the denominator levels.

3. Why is the operating income under normal capacity utilization lower than the other two scenarios?

4. Reconcile the difference in operating income based on theoretical capacity and practical capacity with the difference in fixed manufacturing overhead included in inventory.