Question

The Southern Division manager of Texcaliber Inc. is growing concerned that the division will not be able to meet its current period income objectives. The division uses absorption costing for internal profit reporting and had an appropriate level of inventory at the beginning of the period. The division manager knows that he can boost profits by increasing production at the end of the period. The increased production will allocate fixed costs over a greater number of units, reducing cost of goods sold and increasing earnings. Unfortunately, it is unlikely that additional production will be sold, resulting in a large ending inventory balance.

The division manager has come to Aston Melon, the divisional controller, to determine exactly how much additional production is needed to increase net income enough to meet the division's profit objectives. Aston analyzes the data and determines that the division will need to increase inventory by 30% in order to absorb enough fixed costs to meet the division's income objective. Aston reports this information to the division manager

Is Aston acting ethically? Why?

Answer 1

Absorption costing system is a method where the final finished product will absorb all the cost including fixed cost.

In the words costs absorbed under absorption costing are direct materials, direct labour, variable manufacturing overhead and fixed manufacturing overhead.

In the given case the division manager has come to Aston Melon, the divisional controller, to determine exactly how much additional production is needed to increase net income enough to meet the division's profit objectives knowing that in the present condition production division will not be able to meet its income objectives.

No of units to be produced will be based upon production budget which is prepared based on the demand in the market. It is the policy of the company to work as per the budget unless corrective action plan requires the change in the quantity.

So, it is unethical for Aston Melon to give this information to the division manager. It violates the policy of internal control. It becomes the duty of Aston Melon to report the fact to the top management since, piling up of inventory will effect Working capital of the company.