Question

From a previous Chapter there is a discussion of variable costing and absorption costing. Now, consider the following scenario:

Assume that you are a cost accountant in a small manufacturing firm. You are member of the Institute of Management Accountants (IMA) and have recently become a Certified Management Accountant (CMA).

The firm’s stock is publicly-traded on the New York Stock Exchange. The corporation reports its annual financial statements in conformity with United States generally accepted accounting principles (US GAAP) and prepares its tax returns under United States Treasury regulations.

The company manufactures four unique machines that are distributed throughout the United States. Your primary responsibility within the company is to determine cost of goods sold for the four machines.

During the current year, sales have significantly exceeded production, and inventories have decreased during the year.

As you are preparing cost of goods sold calculations, your supervisor, Ms. Smith, approaches you with a request. Ms. Smith asks you to calculate cost of goods sold for external reporting and for income tax reporting using variable costing.

Required:

1. Explain the impact of complying with Ms. Smith’s request on cost of goods sold and on ending inventories.
2. Would you comply with Ms. Smith’s request? Why or why not?
3. If you determine that you would not comply, what is your course of action? Be specific. (Refer to the Institute of Management Accountants (IMA) "Statement of Ethical Professional Practice" that is included in the Appendix to Chapter 1 of the textbook and is also included under the Resources folder in WT Class.)

Answer 1

Solution 1:

As per the rules of valuation of ending inventories and cost of goods sold; Valuation will be done using Absorption costing approach not variable costing approach.,If Variable costing approach is used, all the fixed overheads will be charged in Statement of Profit and Loss which is technically wrong and is in violation of Tax laws as well as IFRS and Company laws. Fixed Overheads are to be allocated to Units which has been manufactured hence to the units sold and closing stock.

Solution 2:

Ms. Smith request cannot be complied since it will lead to lower valuation of closing stock hence decreasing overall profit.

Solution 3:

As per Statements of Ethical Professional Practice, Member should act in accordance with ethical principles of Honesty, Fairness, Objectivity and responsibility. A member's failure to adhere with it may result in disciplinary action.

If it is not complied, below are the course of action to be applied:

- Discuss the issue with Immediate Supervisor/ Next level if supervisor is also involved.

- Clarify the relevant issue to IMA Ethicas Counselor to obtain a level of understanding of possible law of action.