Final answer:
Profits are higher under absorption costing compared to variable costing when inventory levels increase because absorption costing defers some fixed costs to future periods as part of the cost of goods sold, unlike variable costing, where fixed costs are expensed in the period they occur.
Step-by-step explanation:
The student has inquired about the differences in profit calculation under the absorption costing system compared to the variable costing system. The key distinction between these two costing methods is how fixed overhead costs are treated. In absorption costing, all manufacturing costs including both variable and fixed overhead costs are assigned to produced goods, while in variable costing, only the variable production costs are applied to the units produced, and fixed overhead costs are treated as period expenses. Profits will be higher under absorption costing than under variable costing when inventory levels increase. This is because in absorption costing, some of the fixed costs are included in the inventory valuation and thus deferred to be expensed in the future as part of the cost of goods sold, while in variable costing, fixed costs are expensed in full in the period when they occur, regardless of sales or inventory changes.