Question #1 a) Under which inventory costing method would managers have an incentive to build excess...

Question #1

a) Under which inventory costing method would managers have an incentive to build excess inventory? What is it about that method that provides the incentive? Be sure to justify your answer.

b) What steps can a manager take to reduce the incentive to build excess inventory? Be specific!

Question #2

a) How does the choice of the denominator level capacity impact income reported under variable costing? Be sure to justify your answer.

b) How does the choice of the denominator level capacity impact income reported under full absorption costing? Be sure to justify your answer.

Expert Solution

1. a) Under Absorption costing method managers would have incentive to build excess inventory. The reason being in Absorption costing the closing stock is valued at total product cost including fixed manufacturing cost. Hence the closing stock will be valued higher leading to higher profits for the period

b) The profits for the period has to be checked based on Variable costing method to reduce inventory build up. In Variable Costing the fixed manufacturing cost is charged to the period in which it is incurred. Hence Stock is valued at Variable Product cost only. So higher inventory build up will not lead to higher profits for the period.

2 a) Choice of denominator level capacity do not affect the income reported under Variable costing. The reason being fixed cost is treated as period cost and charged to the period in which it is incurred. Fixed manufacturing cost is not absorbed for the products manufacturing and hence not part of product cost.

b) In Absorption costing the fixed manufacturing cost is part of product cost based on production volume for a particular period. Hence lower the volume in denominator higher, the fixed manufacturing cost per unit which will increase product cost. When product cost is higher the closing stock also will be valued higher. Similarly if denominator is higher due to higher volume, the fixed manufacturing cost per unit will be lower and product cost will also be lower.

ekkarill92 answered 2 years ago

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