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These opportunities arise when production exceeds sales and occurs as a result of the differences between absorption costing and variable costing.
When using GAAP based absorption costing as compared to internally used variable costing, if more was produced than sold, then there was a chance for income manipulation.
Traditional absorption costing systems tend to overstate the costs of high-volume products and understate those of low-volume products.
In absorption costing, manufacturing costs consist of direct costs (variable costs) and indirect manufacturing costs(fixed costs).
Most notably, the absorption costing income statement, which treats direct materials, direct labor, and variable and fixed overhead as product costs and all selling and administrative expenses as period costs, penalized managers' inventory-reduction efforts with a major hit to the bottom line.
In our article in the previous issue, we used absorption costing principles to construct a detailed budget for a fictitious manufacturing company.
In its European subsidiaries, Andreas STIHL employs GPK along with traditional GAAP-type reporting using a full absorption costing system.
The following worked example of budget preparation using absorption costing is of a fictitious manufacturing company that has sales volume as its principal budget factor.
Although they are concerned that firms using absorption costing may produce distorted profitability analyses, perhaps multinationals have a different view of costs compared with smaller companies, since they have a wider range of strategic options.
Absorption costing cannot be used for this analysis, since it includes production overheads--ie, costs that are fixed in the short term.
It usually involves imposing a particular format--always a variation on the absorption costing theme--showing a total cost per unit and hence a profit per unit.