Managerial Accounting Practices - Essay Example

Managerial Accounting Practices Table of Contents Absorption Costing 3 Variable Cost 3 Absorption Cost Vs Variable Cost 4 Ethical Practice 5 Stakeholder’s Reaction 5 Unit Cost as per the Two Methods 6 Under Variable Costing Technique 7 Under Absorption Costing Technique 9 References 11 Absorption Costing The absorption costing system is highly influenced by the level of production and the level of sales which affects the profitability of any manufacturing concern. This is primarily because of the incorporation of fixed manufacturing outlay into the value of work-in-progress and value of finished goods stock. If the stock leftovers are present at the end of the accounting period, in that case, fixed manufacturing overhead charge, included within the stock assessment, will be transferred to the following period. Variable Cost In the process of variable costing, the costing can be altered as per the changes in the production level. The variable costing is required for analysis of the performance, to find out the exact value required for the purpose of production of any product and the expenses associated to that product over a period of time. It shows the exact amount of profit or loss made during that particular period. But it is not the same in absorption costing as the profit generated in the report is actually the paper profit. As the fixed cost associated with the left over stock gets transferred to another period, it affects the profit or loss of another period even the cost being of the previous period. According to the concepts of absorption costing, the manufactured products absorb all the cost that is required for the process of manufacturing. But as per the variable costing production costs comprise all of the variable manufacturing costs. Absorption Cost Vs Variable Cost The only disparity between variable costing and absorption costing is the behavior of fixed overhead (i.e. the treatment of fixed selling and administrative costs are expenses under either of the methods). While variable costing is often regarded as the most apt system to help the company’s management in initiating decisions, it is not permissible for the purpose of external financial reporting. The fixed cost under variable costing method is related to goods produced, sold goods and left over goods. The cost of the left over goods is transferred to the period of sales of those goods while in variable costing it is not so. In fact, it comes under the same period of production (Oregon State University, n.d.). Ethical Practice The concept of absorption cost meets the standard of the GAAP. And overproducing in the absorption of coating concept does not bring in the ethical issue. So it is not unethical to practice overproduction in the manufacturing concern using absorption cost concept. It reports the fixed cost of manufacturing on the period cost basis of goods sold within the period and rest is carried to the period of sales of those goods. Stakeholder’s Reaction Internal stakeholders are the integral part of the management. But the external stakeholders are less informed about the happenings within the management. So, this might affect the external stakeholders. As per the absorption costing technique, fixed manufacturing overheads are absorbed into the cost of goods produced and are only charged against profit in the period in which goods are sold. But in variable costing technique the fixed manufacturing cost is treated during the same period, as the period cost.   Under Variable Costing Method Under Absorption Costing Method No. of Units Produced 21000 (units) 21000 (units) No. of Units Shipped 20000 (units) 20000 (units) No. of Units left in the Inventory 1000 (units) 1000 (units ) Predetermined Fixed Over Head Rate 100.00 per unit 95.240 per unit Fixed Cost Stayed in the Inventory 2000000.00 1904761.9 From the above table, we see the two methods costing and the inventory status. Under the absorption costing method, the inventory of 1000 units gets carried over to the next period along with the cost associated with the 1000 units. But in variable costing the cost is not transferred to the next period. Unit Cost as per the Two Methods Under Variable Costing Units 21000.00 Variable cost 600000.00 Fixed Cost 2000000.00 Total 2600000.00 Unit cost 123.81 Under Absorption Costing Units 20000.00 Variable cost 600000.00 Fixed Cost 1904761.90 Total 2504761.90 Unit cost 125.24 From the above tables, we can see that the unit cost in the variable costing method is $123.81 whereas, under the absorption costing method, the unit cost is $125.24. Under Variable Costing Technique Variable Costing Income Statement     SALES 20000.00 4000000.00 less Total V.C 600000.00 600000.00   CONTRIBUTION   3400000.00 less Total F.C. 2000000.00 2000000.00   PBT   1400000.00 Under Absorption Costing Technique ABSORPTION COSTING INCOME STATEMENT   SALES 20000.00 4000000.00 less Cost of Goods Sold       BEG FIN GOODS INV 0.00     COGM 2000000.00     GOODS AV 4 SALES 2000000.00   less END FIN GOODS INV 95238.10     COST OF GOODS SOLD 1904761.90 1904761.90   G/M PROFIT   2095238.10 less Variable cost   600000.00   PBT   1495238.10 After preparing the statements, it is observed that the profit before income tax (PBT) in variable costing method is reported to be $ 14, 00,000. According to the absorption costing model, the profit before tax is reported to be $ 14 ,95,238.10. Under the absorption costing model, the profit before income tax is reported to be higher than in that of the variable costing model. The reason behind such phenomena is because of the factor that the cost of inventory at the end of the period in absorption costing model gets transferred to another period along with the inventory and it is charged when that particular inventory will be sold off. But under the variable costing model the cost of the good manufactured is fully charged to the account irrespective to what has been sold and what lies in the inventory. The cost does not get carried to next period along with the inventory which lies at the end of the period. The absorption model is adapted mostly in the manufacturing concern and is followed when it makes report according to the GAAP. But normally, variable costing technique is used in the domestic environment. For the purpose of external reporting, the management needs to use the absorption costing method as it is required by GAAP. It is also required while filing annual income tax return. But for internal purpose, the variable costing method is comparatively greater useful. With all other things being equal, increase in sales should result increase in income and decrease in sales would sales should result in decrease in income. So, it is imperative that the adaption of variable costing for internal decision will remove the impact of the change in the production level of income. References Kimmel. D. P. & Weygandt. J. J. Kieso E. D., (2008). Accounting. John Wiley and Sons. Oregon State University, (No Date). Management Accounting: Concepts and Techniques. OSU College of Business. Retrieved Online on July 16, 2010 from http://classes.bus.oregonstate.edu/winter-06/ba321/Caplan/Management%20Accounting%20Chapter%2015.htm Strathmore University. (No Date). Marginal and Absorption Costing. eLearning System. Retrieved Online on July 16, 2010 from http://www.elearning.strathmore.edu/file.php/537/MARGINAL_AND_ABSORPTION_COSTING.pdf Weygandt. J. J. & Kimmel. D. P., Kieso. E. D., (2009). Management Accounting: Tools for Business Decision Making. John Wilwy and Sons. Read More