It's approaching year-end, and your president has asked you, the management accountant, to visit his office for a heart-to-heart talk. After he closes the door, he tells you that profits for the year will end up below plan and that he's disappointed.
He had just returned from his normal Friday country club lunch with other local manufacturing company executives. He tells you that some of his peers had frankly mentioned the same problem with their companies, and that one of them had whispered the following in his ear:
I learned something new from my management accountant. Before the year started he had us change from a variable costing system to an absorption costing system. Because of that, as we approached this year's end and were a little behind in profitability, we increased our production, even though we didn't have orders. As a result, our profits improved on our reported income statement.
The president asked you to explain all of this to him so together you could decide whether to do the same thing, if needed, at the end of next year to improve profitability.
In a report to him include the following information:
•What exactly is absorption costing vs. variable costing?
•In your opinion, describe whether you think overproducing is an ethical practice and why or why not. Include discussion of which stakeholders might react, and how they would react if they knew about this practice.
•Using the following data, calculate the difference between reported income and unit costs under absorption and variable costing by answering these questions:
1.How many units of production were
■produced?
■shipped?
■left in inventory?
2.What is this firm's predetermined fixed overhead rate?
3.How much of the firms fixed costs stayed in inventory
■under variable costing?
■under absorption costing?
4.Calculate the unit cost
■using variable costing.
■using absorption costing.
5.Based on this firm's predetermined fixed overhead rate, how much of the firms fixed costs ended up on the year's COGS and income statement
■under variable costing?
■under absorption costing?
6.Under which method (variable or absorption costing), will reported profits be higher? Explain why.
1 answer