Stellar Packaging Products uses absorption costing to compute additional compensation eligibility for managers. In December, Stellar Packaging Products’ controller, Robin Simmons, noted that a considerable production overrun was experienced, resulting in increased ending inventories for its major customer, Estrella Coffee Company. Simmons approached Frank Moses, the production manager, regarding these facts. Moses indicated that indeed, the production overrun was deliberate and completed in order that more overhead application would occur in December, and “everyone would make their year-end bonus.”

Would the situation have changed if the company used variable costing as a basis of additional compensation? Why or why not?

For this discussion:

Support your position.

Select two peer posts and comment on the content of their posts. Does your selection differ from that of your peers? If so, how does that response contrast to your own?

Peer Post !:

Absorption Costing is a GAAP compliant method of accumulating costs involved in a production process and assigning the costs to an individual product (Garrison, Noreen, & Brewer, 2015). A given product has many fixed and variable costs, but under absorption costing, they are not expenses when the company pays for them (Garrison et al, 2015). Instead, they remain in inventory as a tracked asset until the product is sold; then it is listed as cost of goods sold (Garrison et al, 2015). The advantages of absorption costing is that it given a more accurate view of net profitability and is especially helpful when a company manufactures product during a time frame but does not sell them (Maverick, 2015). It is also the most standardized format and used by the most companies because the IRS requires its use and if companies use variable costing, they still have to comply with the IRS requirements of filing in a absorption costing format as well (Maverick, 2015). The main disadvantage would be that the company has a tendency to "carry" fixed costs if the products are not sold in real time (Maverick, 2015). This can lead to the company appearing to be more profitable that it actually is.

Variable Costing is a non-GAAP compliant method of accumulating costs that varies with the output of production (Garrison et al, 2015). These costs are more variable because they depend of the outcome of the company's production volume for a given timeframe (Garrison et al, 2015). Variable costs will go up if production volume rises and go down if production falls (Garrison et al, 2015). The advantages to the variable costing method is that it allows a company to get an accurate break even and use cost value profit analysis (CVP) (Garrison et al, 2015). This knowledge of break even can be helpful as companies are figuring out the profitability of a given line of production vs. a different line. It provides an apples-to-apples comparison of profitability (Maverick, 2015).

Based on the example question, it appears that by using absorption method alone, it had a net operating profit loss of $11,009. It appears that having an element of variable costing methods would not allow the numbers to be worked to get to a bonus that Moses does not deserve.

References:

Garrison, G. H., Noreen, E. W., & Brewer, P. C. (2015). Managerial accounting (15th ed.). New York City, NY: McGraw-Hill Education.

Maverick, J. B. (2015, May 27). What are some of the advantages and disadvantages of absorption costing? Retrieved from http://investopedia.com

Variable Costing Unit Production CostNovemberDecemberJanuaryUnits Produced400007000040000Selling price$4.00Units Sold400001000060000Direct materials$0.80Direct Materials$0.80$0.80$0.80Direct labor$0.40Direct Labor$0.40$0.40$0.40Variable manufacturing overhead$0.20Variable manufacturing overhead$0.20$0.20$0.20Variable costing per unit cost$1.40Fixed manufacturing overhead$0.74$0.42$0.74 (Fixed amount divided by units produced)Absorption Costing Unit Product Cost$2.14$1.82$2.14Variable Costing of Goods SoldAbsorption Costing Income StatementsNovemberDecemberJanuaryNovemberDecemberJanuaryVariable Unit Production Cost$1.40$1.40$1.40Sales$160,000$40,000$240,000Total Units Sold400001000060000Costs of goods sold$85,600$18,200$128,400Variable cost of goods sold$56,000$14,000$84,000Gross margin$74,400$21,800$111,600Selling and administrative expense$9,867$7,467$11,467Selling and Administrative ExpensesNet operating income (loss)$64,533$14,333$100,133NovemberDecemberJanuaryVariable selling & admin expense$3,200$800$4,800Fixed selling & admin expense$6,667$6,667$6,667NOTE: All numbers used refer back as a reference to Module 4 - Critical Thinking exercise for Stellar Packaging ProductsTotal selling & admin expense$9,867$7,467$11,467Variable Costing Contribution Format Income StatementsNovemberDecemberJanuarySales$160,000$40,000$240,000Variable Expenses Variable cost of goods sold$56,000$14,000$84,000 Variable selling & admin expense$3,200$800$4,800Total variable expenses$59,200$14,800$88,800Contribution Margin$100,800$25,200$151,200Fixed Expenses Fixed manufacturing overhead$29,542$29,542$29,542 Fixed selling & admin expense$6,667$6,667$6,667Total Fixed Expenses$36,209$36,209$36,209Net operating profit (loss)$64,591-$11,009$114,991

Peer Post 2:

Absorption costing is frequently referred to as full costing method. It is a costing system that treats all costs of production as product costs, regardless if they are variable or fixed. The cost of a unit of product under absorption costing method consists DM, DL, and both fixed and variable overhead. It allocates a portion of fixed and variable manufacturing overhead to each unit produced. Absorption costing includes all costs of production as period costs.

Variable costing is sometimes referred to as direct costing or marginal costing. Fixed manufacturing overhead is treated as a period cost. It includes DM, DL, and a portion of manufacturing overhead to each unit. The cost of production that vary with the output are treated as product costs. The cost of a unit of product in inventory of COGS under this method does not contain any fixed overhead costs.

Under absorption costing and variable costing different net operating incomes are produced. Reason being is that product cost and period costs differ. For example, while both factor direct materials, direct labor and variable manufacturing overhead as product costs only absorption cost includes fixed manufacturing overhead for product cost. As far as period costs both account for fixed and variable selling and administrative as period cost but only variable costing accounts fixed manufacturing overhead as period cost.

Relation between production and sales for the period

Effects on inventories

Relation between absorption and variable costing net operating incomes

Units produced = Units sold

No change in inventories

Absorption costing net operating income = Variable costing net operating income

Units produced > Units sold

Inventories increase

Absorption costing net operating income > Variable costing net operating income

Units produced < Units sold

Inventories decrease

Absorption costing net operating income < Variable costing net operating income

Net operating income is higher under absorption costing because fixed manufacturing overhead cost is deferred in inventory under absorption costing as inventories increase. If Stellar Products were to use a Variable costing system a lower net operating income would have been reported and less if any year-end bonus would be compensated.

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