The correct answer is C. This can be calculated by multiplying the increase in finished goods inventory of 1,000 units (2,000 units produced less 1,000 units sold) by the fixed production cost per unit that will be included in absorption costing closing inventory valuation.

The distracters were all based around the $4,000 over-absorption of fixed production cost. Distracter A suggests that the difference in profits will be equal to the over- absorption of fixed production cost, whereas B and D suggest that it is due to a difference in inventory valuation and over-absorption of fixed production cost. Incorrect answers were roughly evenly spread around the 3 distracters, suggesting a misunderstanding of under- or overabsorption (or possibly a high level of guessing).

Under- or over-absorption adjustments to profit do not cause a difference between marginal and absorption costing profits. They simply ensure that absorption costing charges the same amount of fixed overhead as marginal costing.

If we look in more detail at the situation it is apparent that the over-absorption of $4,000 was caused by the production of 400 units more than budgeted ($4,000 ^ $10 per unit). Budgeted production would therefore be 1,600 units (2,000 units actually produced less the 400 units above).

It follows that budgeted fixed production cost was therefore 1,600 units x $10 per unit = $16,000. As actual fixed production cost was equal to budgeted, marginal cost fixed production costing would have recorded an actual fixed production cost of $16,000.

Absorption costing would have charged $20,000 of fixed production cost to product (2,000 units produced x $10 per unit), however the adjustment for over-absorption would have corrected this overcharge and reduced this cost by $4,000, resulting in the same fixed production cost as marginal costing.

The important point is that it is not under- or over-absorption that causes the difference between profits under absorption and marginal costing principles. The difference in profits is caused by the difference in finished goods inventory valuations.