Bài giảng môn Kế toán, kiểm toán - Chapter ten: Criticisms of absorption cost systems: Incentive to over - Produce

Criticisms of Absorption Cost Systems: Incentive to Over-produceChapter TenCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinOutline of Chapter 10 Criticisms of Absorption Cost Systems: Incentive to OverproduceIncentive to Overproduce Variable (Direct) Costing Problems with Variable Costing Beware of Unit Costs 10-2Connection to Other Chapters Chapter 10’s theme: Traditional absorption costing can result in poor operational decision making in a manufacturing firm. Chapter 1: No single accounting system can satisfy decision making, decision control, and external reporting. Chapter 2: Accounting costs include fixed and variable costs. Chapter 9: Described mechanics of absorption costing10-3Incentive to Overproduce Under absorption costing, manufacturing managers can defer recognition of fixed manufacturing costs by building ending inventory rather than deducting those fixed costs in the year incurred. Ending Inventory  Asset  Unexpired cost  Expense deducted when items are sold next year Period cost  Expired cost  Expense deducted in year incurred10-4Increasing Production Reduces Average CostsAbsorption costing treats fixed manufacturing costs as product costs. When more units are produced than sold and absorption costing is used, some of the fixed costs are allocated to ending inventory (asset account) and become recognized in a future period’s cost of goods sold (expense account).Reconciling case 1 and 2: Net Income Ending InventoryCase 1: 2000 produced, 2000 sold $ 4,000 $ 0Variable cost in ending inventory 1,000Fixed cost in ending inventory 909 909 Case 2: 2200 produced, 2000 sold $ 4,909 $ 1,909Also see Self Study Problems.10-5Reducing Overproduction: Performance EvaluationTo reduce overproduction, modify the performance evaluation system.Inventory holding charge against divisional profitsResidual income technique from Chapter 5Variable instead of absorption costingVariable costing is discussed.10-6Reducing Overproduction: Decision RightsTo avoid the overproduction incentive of absorption costing, reduce the decision rights of the production managers.Senior managers strictly monitor inventory levelsRemove production manager’s right to build inventory level greater than amount authorized by top management.Just-In-Time (JIT) production so that customer orders drive inventoryRemove production manager’s right to build inventory level greater than amount ordered by customers.See Chapter 14.10-7Variable Costing: DefinedVariable costing treats all fixed manufacturing costs as period costs to be deducted from net income (expensed) in the period incurred.Under variable costing, only variable manufacturing costs flow through to the inventory accounts.Variable costing is also known as direct costing since the variable manufacturing costs consist of direct materials, direct labor, and variable overhead.Variable costing is one of the methods of setting transfer prices. See Chapter 5.10-8Comparing Absorption and Variable CostingSimilarities:Under both methods all fixed and variable manufacturing costs will eventually become expenses deducted in computing net income.Variable manufacturing costs flow through the finished goods inventory account and are expensed in the period goods are sold.Differences:Under absorption costing, fixed manufacturing overhead is a product cost and flows through inventory account and is expensed when goods are sold.Under variable costing, fixed manufacturing overhead is period cost and expensed in period incurred.10-9Example Comparing Absorption and Variable (extension of Year 2 example in Table 10-5) Absorption Variable CostRevenue (10,000 units) $110,000 $110,000Direct materials and labor - 20,000 - 20,000Variable Mfg OH - 30,000 - 30,000Fixed manufacturing overhead - 36,364 - 40,000Net income $ 23,636 $ 20,000Ending inventory (1,000 units):Variable costs $ 5,000 $ 5,000Fixed manufacturing overhead 3,636 noneEnding inventory cost $ 8,636 $ 5,00010-10Problem with VC: Classifying Fixed vs. Variable OverheadUnder both absorption and variable costing, managers have an incentive to defer costs by getting more costs into ending inventory rather than cost of goods sold expense in current period.To defer costs under variable costing, managers can:Classify more overhead as variable rather than fixed so that variable cost per unit increases.Produce more units than sell so that ending inventory increases and the variable costs associated with that ending inventory are deferred until next period.Do both of the above.10-11Problem with VC: Opportunity Cost of CapacityVariable costing does not adequately measure the opportunity cost of using plant capacity for other purposes.Although opportunity costs are inherently hard to measure, they are usually best estimated as a combination of fixed and variable costs.However, note that if the firm has excess capacity, using fixed charges in unit costs overstates opportunity cost and discourages the use of excess capacity.10-12Problem with VC: Absorption Required for External ReportsAbsorption costing for products is required for:External financial reportingMatch cost of goods sold to revenues from sale of those goods.US federal income tax reportingThe government tax collectors want taxpayers to defer deduction of fixed costs to raise current taxable income and taxes paid.Reconciling between variable costing for internal purposes and absorption costing for external purposes is costly.If benefits of separate systems are not great, use one costing system for both internal and external reports.10-13Beware of Unit Costs Unit costs are average costs that include some directly traceable costs and some allocated variable and fixed costs incurred. Unit costs  opportunity costs because opportunity costs are estimates of foregone benefits from actions that could, but will not be undertaken (Chapter 1). Unit costs  marginal costs because marginal costs are the cost of producing one more unit rather than the average cost (Chapter 1).10-14Beware of Historical vs. Future CostsAs the firm expands or contracts into areas of its cost curve where it has not been before, there is no historical information regarding the level of costs in these unexplored regions.Example:Natural gas prices are $0.20 per cubic yard up to 500,000 cubic yards and then $0.30 per cubic yard thereafter.10-15