Accounting for Decision Making - Essay Example

?Running Head: ABBREVIATED OF YOUR CHOICE (all caps) and Section # of Accounting for Decision Making Discussion Did Mr. Rosen improve his performance for the second quarter? Indicate the information you used for your assessment Analyzing the statements prepared under the absorption system, the company seems to have made a significant improvement in the second quarter. The gross profit margin has improved from 28% in the first quarter to 40% in the second quarter; whereas the net profit margin has increased from 14% in the first quarter to 28% in the second quarter as seen in appended figure 5. These two important measures of profitability show that the company has made remarkable progress over the nest quarter signifying increased efficiency and effectiveness. However, this is not the case. The statements prepared under the contribution margin rules show that the contribution margin has not improved between the two quarters. The statement prepared implied the company has contribution margin of 52% in the both the quarters, as seen in figure 5, implying that there has no increase in efficiency of controlling variable costs. Therefore, the profit net profit margin under the contribution margin statement remains 14% in both quarters. The increase in the net income under the absorption id due to the allocation of the fixed costs over a greater number of units produced. Mr. Rozen has increased the production levels from 25,000 units to 50,000 units. This has reduced the allocation of fixed costs from $24 in first quarter to $12 in second quarter. Thus the cost of goods sold has decreased by $300,000 which has increased the gross margins and the net margin. Can you make any suggestions for reporting in the future? Absorption approach is constructive for external reporting. It does not provide the competitors with too much information which they can use to their advantage such as the product cost, the material costs, the labor costs and others. Similarly, this approach considers the costs to the finished inventory as an asset on a balance sheet until it is sold. Therefore, this helps the company to improve its metrics for external stakeholders. Likewise, the Generally Accepted Accounting Principles, or GAAP, requires the publicly held companies to prepare their statements under the absorption approach. (Taylor, 2010) However, for internal users and decision-making, contribution margin approach to income statement is quite useful. Variable costing allows the internal users to understand the product cost of unit which will allow them to decrease variances between actual and budgeted amounts. This helps in controlling costs and overall profitability of the company. With this approach, the managers can make better decisions in a fluctuation sales environment and helps them to accurate the cost of productions for future periods. Likewise, this approach helps to observe an impact of each and every product on the overall profitability of the company. Some products are better absorbers of fixed costs and increase the earnings of the company. Therefore, an adequate decision can be made regarding the discontinuation of product which will least affect the earnings. (Scott, 2012) Do you think Mr. Rosen should be seriously considered for the CEO position? Why or why not? Mr. Rozen has based his decision to increase the production on inadequate information. He has not pondered hard over the impact of his decision on the company’s operations and profitability. With the increase in production, Mr. Rozen only allowed for a better allocation of the fixed costs over a larger quantity of units. This only allowed for the costs to be temporarily seen as assts on the balance sheet in the form of inventory. However, Mr. Rozen must understand that the huge amount of inventory that has been created will need to managed and properly maintained over the nest quarter for the sales in future. This will increase inventory handling costs and storage costs that will have negative impact on the profitability of the company. Similarly, Mr. Rozen has not realized the huge investment that has been stuck in the form of inventory; thereby decreasing the quick ratio of the company. This decreasing ratio will imply the worsening ability of the company to pay short term obligations. This investment could otherwise be used to earn a return on marketable securities. Similarly, Mr. Rozen has made no efforts to increase the sales of the company when he decided to increase the production. An increase in sales might have helped to balance the negative impact of the production increase on the company’s profitability. Therefore, I must say that an inflation of the profits without any increase in the efficiency and effectiveness of the company operations is only misleading. With this decision, Mr. Rozen has misled the external stakeholders that the company has improved in its operations and profitability. I believe that Mr. Rozen should not be considered for the CEO position. Discuss three shortcomings of the absorption approach for internal decision-making. The three major shortcomings of the absorption approach for internal decision making are: 1. Inflation of Profits The absorption approach allows for inflation of the profits of the company without any increase in efficiency or effectiveness. (Taylor, 2010) In this case, the company increased the income by $350,000 with any increase in sales volume or price or reduction in costs. The increase was due to a greater number of units produced which allowed for allocation of periodic fixed costs over a larger number of units. 2. Hiding Costs in Inventory Under the absorption approach, the company allocates a part of the fixed costs-overheads to the finished goods inventory. Since, inventory is seen as an asset on a company’s balance sheet; the fixed overhead costs allocated to it are rolled into the inventory as an asset on the balance sheet rather than as a cost in the income statement. (Taylor, 2010) In this case, half of the fixed overheads $300,000 in the second quarter have been allocated to the ending inventory. 3. Insufficient Information for Managerial Decision-making Absorption approach provides inadequate information to the managers for making the best decisions that will benefit the company. It does not provide the company with the appropriate product cost or absorption of fixed cost per unit. Therefore, it becomes difficult to make a decision regarding the discontinuation of a product or a start of the new profitable product. (Taylor, 2010) References Books Fridson, M. (1995). Financial statement analysis. New York: Wiley. Harrison, W., and Horngren, C. (2001). Financial accounting. Upper Saddle River, NJ: Prentice Hall. Hilton, R. (1994). Managerial accounting. New York: McGraw-Hill. Horngren, C. (1982). Cost accounting. Englewood Cliffs, N.J.: Prentice-Hall. Jiambalvo, J. (2001). Managerial accounting. New York: Wiley, m. Warren, C., and Reeve, J., et al. (2005). Financial & managerial accounting. Mason, Ohio: Thomson/South-Western. Websites Accountingformanagement.org (2010). Variable costing versus absorption costing | Accounting For Management. [online] Retrieved from: http://www.accountingformanagement.org/variable-vs-absorption-costing/ [Accessed: 29 Apr 2013]. Accountingtools.com (2013). Contribution Margin Income Statement - AccountingTools. [online] Retrieved from: http://www.accountingtools.com/contribution-margin-income-sta [Accessed: 29 Apr 2013]. Scott, S. (2012). Arguments for Variable Costing in Managerial Decision Making. [online] Retrieved from: http://smallbusiness.chron.com/arguments-variable-costing-managerial-decision-making-35925.html [Accessed: 29 Apr 2013]. Taylor, E. (2010). Disadvantages of Absorption Costing for a Company. [online] Retrieved from: http://smallbusiness.chron.com/disadvantages-absorption-costing-company-22732.html [Accessed: 29 Apr 2013]. Appendix Division Income Statement (Absorption) For the Quarter Ending March 31, 2013 Production: 25,000 units Sales (25,000 units) $2,500,000 Cost of goods sold $1,800,000 Gross Profit $700,000 Selling & general expenses $350,000 Net income $350,000 Figure 1 Division Income Statement (CM) For the Quarter Ending March 31, 2013 Production: 25,000 units Sales (25,000 units) $2,500,000 Less: Variable cost $1,200,000 Contribution Margin $1,300,000 Less: Fixed Overheads $600,000 Less: S&G Expenses $350,000 Net Income $350,000 Figure 2 Division Income Statement (Absorption) For the Quarter Ending June 31, 2013 Production: 50,000 units Sales (25,000 units) $2,500,000 Less: COGS   COGM ($3,000,000)   Closing Stock ($1,500,000)   Cost of goods sold $1,500,000 Gross Profit $1,000,000 Selling & general expenses $350,000 Net income $650,000 Figure 3 Division Income Statement (CM) For the Quarter Ending June 31, 2013 Production: 50,000 units Sales (25,000 units) $2,500,000 Less: Variable cost $1,200,000 Contribution Margin $1,300,000 Less: Fixed Overheads $600,000 Less: S&G Expenses $350,000 Net Income $350,000 Figure 4   1st Quarter 2nd Quarter Net Profit Margin 14.00% 26.00% Gross Profit Margin 28.00% 40.00% Contribution Margin 52.00% 52.00% Figure 5 Division Income Statement (Absorption) For the Quarter Ending March 31, 2013 Production Cost per Unit   1st Quarter 2nd Quarter Absorption $72 $60 Cont. Margin $72 $72 Figure 6 Read More