The Garrard Company manufactures trendy, high-quality moderately priced watches. As Garrard's senior financial analyst, you are asked to recommend a method of inventory costing.

The CFO will use your recommendation to prepare Garrard's 2014 income statement. The following data are for the year ended December 31, 2014.

Requirements

1. Prepare income statements under variable and absorption costing for the years ended December 31, 2014.

2. What is Garrard'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 could you recommend to the CFO? Why?

Beginning Inventory, January 1, 2014 87,000 units

Ending Inventory, December 31, 2014 33,000 units

2014 sales 315,000 units

Selling price (to distributor) $23.00 per unit

Variable manufacturing cost per unit, including direct materials $5.70 per unit

Variable operating (marketing) cost per unit sold $1.40 per unit sold

Fixed manufacturing costs $1,242,000

Denominator-level machine-hours 5,400

Standard production rate 50 units per machine-hour

Fixed operating (marketing) costs $1,060,000