Accounting for Managers

Management Cost Accounting
121
The main disadvantage of absorption costing is that it cre-
ates a tendency to overproduce, because the average cost per
unit lowers as more units are produced. If average cost per unit
and net income are part of a manager’s evaluation, absorption
costing will make performance look better.
In the short term, cost of goods sold is lower and net income
is higher because some of the fixed costs are left in the ending
inventory. Notice that the difference in operating income is the
amount of fixed costs absorbed in inventory: $40,000 = 10,000
Ultimates at $4 fixed manufacturing overhead. 
One useful corrective for this potential problem is to adopt a
just-in-time manufacturing capability. JIT naturally tends to
reduce high inventories. Other ways include setting and enforc-
ing a management threshold for inventories, using something
besides short-term measures like net income, or going to a
variable costing system. Like many management accounting
issues, this condition is not necessarily a problem until it
Sales Revenues
Less COGS
Beginning Inventory
Add COGM
Goods Available for Sale
Ending Inventory
Account Names
Account Sums
Aggregated Sums
and Totals
Absorption
Variable
$2,000,000
—
$800,000
$800,000
$160,000
$640,000
$2,000,000
—
$600,000
$600,000
$120,000
$480,000
Gross Margin
Less Variable Cost Overhead
Less Selling and Admin Overhead
Variable
Fixed
Operating Income
$1,360,000
$120,000
$120,000
$1,120,000
$200,000
$1,320,000
$120,000
$120,000
$1,520,000
$1,080,000
General Widget Company, Inc.
December 31, 200_
Figure 6-3. Comparison income statement
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