Final answer:
Profits under variable costing are higher than under absorption costing when inventory levels decrease, because absorption costing allocates fixed production costs to inventory, which reduces current period profits when inventory is sold.
Step-by-step explanation:
When considering whether profits calculated under the variable costing system are higher than those under the absorption costing system in relation to inventory levels, it is essential to understand how each costing method treats fixed manufacturing overhead costs. Variable costing includes only variable production costs in the cost of inventory, whereas absorption costing includes both variable and fixed production costs.
Profits under the variable costing system are higher than those under the absorption costing system when B. Inventory levels decrease. This is because, in the absorption costing system, some fixed production costs are allocated to each unit of inventory. When inventory levels decrease, those fixed costs are released from inventory and expensed in the current period, reducing current-period profits. In contrast, with variable costing, fixed overhead costs are expensed in the period in which they are incurred, regardless of changes in inventory levels. Therefore, reducing inventory levels has no immediate effect on profits calculated under variable costing.