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 CEO will use your recommendation to prepare Zwatch’s 2009 income statement. The following data are for the year ended December 31, 2009:

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.
1. Prepare income statements under variable and absorption costing for the year ended December31, 2009.
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 CEO?Why?

Beginning inventory, January 1.2009                                       85,000 units

Ending inventory, December 31, 2009                                     34,500 units

2009 sales                                                                                      345,400 units

Selling price (to distributor)                                                        $22.00 per units

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

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