A. This answer results from two errors: (1) Treating the fixed selling and administrative costs as product costs. Fixed selling and administrative costs are period costs and are expensed as incurred. And (2) treating the fixed manufacturing cost as a period cost. Under absorption costing, fixed manufacturing overhead is applied to units of production, and the cost for unsold units remains in inventory and is not expensed.

B. There are two ways that we can solve this problem. The first is to calculate a full absorption costing income statement. The second is to use the differences between variable and absorption costing to calculate the difference between the two methods. Since we are given the variable costing income, we can then back into the absorption costing income. The difference between the two methods is the treatment of fixed manufacturing overhead. Under variable costing it is expensed, but under absorption costing it is treated as a product cost. Since the fixed factory overheads were $1,200 and they produced 1,200 units, the fixed factory overhead per unit was $1. Since production was 1,200 units and sales were only 1,000 units, inventory increased by 200 units. This means that the fixed factory overhead related to those 200 units is not on the income statement, but on the balance sheet. Therefore, the absorption method income will be $200 higher than the variable method income, or $2,000.

C. This is the operating income under variable costing.

D. This answer results from treating the fixed selling and administrative costs as product costs. Fixed selling and administrative costs are period costs and are expensed as incurred.