Question

1. Discuss possible ways for manipulating profits under the absorption costing system.

2. Do you find it ethically acceptable if management resorts to such techniques?

Answer 1

1. There are several ways for manipulating profits under the absorption costing system.

Misrepresentation

The cost of overheads is included with labour and direct material cost in the total production cost, thus there is a possibility to hide some of the cost by allocating them to production cost to which it does not belong. For example, expense incured on entertainment is allocated to marketing expense.

Uneven expensing

Some of the expenses are incurred on yearly basis and then expensed out at a fixed amount every month. To increase the profit for a particular month, this expense can be expensed out (adjusted) in prior month income statement, which is rarely to be checked by anyone.

Manipulation of Assets

Assets can be manipulated at higher value than the company actually has. If the company has a closing inventory of 100 units of finished goods at the cost of $5 each. Then in the next accounting period the beginning inventory value is $500, but the variable cost get reduce in this period, thus the inventory is stated at higher value than the company has.

Hiding Bad Months

The company can hide the bad months by doing adjustments to the cost of manufacturing in certain month to show stable profit percentage by reallocation some of the expenses in the prior month, and then again doing adjustment to reallocate the cost to the correct month before the final audit and these adjustments may not even get noticed if the overall performance is good.

2. No, none of these partices are ethically acceptable if management resorts to such techniques.