Question

Ethics is a concern for financial accounting and managerial accounting. What are the potential ethical issues associated with Absorption. There are opportunities to be unethical; discuss the potential ethical issues.  

Answer 1

Ethics are no doubt the utmost concern for financial accounting and managerial accounting. But, there are certain ethical issues associated with Absorption costing method.

Absorption method is ethical as it is required by GAAP (Generally Accepted Accounting Principles) for external reporting, but it provides certain loopholes to be unethical as follows:-

1. Cost Misrepresentation

In absorption costing all the costs (fixed and variable) are absorbed in manufacturing of an item, along with labour and raw material cost.

2. Manipulation of Profits

When absorption costing method is used then the income statements can be easily manipulated by unethically changing the values of costs and inventory in a manner to represent company's performance better than the actuals.

3. Overvaluing Assets

Under absorption costing the income statement may show a higher asset value than the company actually has. Therefore, the value of inventory can be easily improved to manipulate financial statements.

4. Conceal bad performances

If there is less sales or loss in a month then such loss can be concealed by adjusting the allocated cost from that month to upcoming month, in order to reduce or hide losses.