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Variable Costing vs. Absorption Costing

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You are the vice president of operations for a small manufacturing company that uses the absorptive method of accounting for fixed manufacturing overhead, and you are approaching the end of the year. The accounting manager just visited some of your supervisors and said that the profitability of the company can appear better if more products were produced, even if they are not all sold right away. Many of the supervisors do not understand how this makes sense and asked you to explain it. You decide to meet with all the production supervisors to explain this.

Explain how the profitability of the company can be made to look better if they were to produce more products, even if they are not all sold right away.

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Solution Summary

This solution explains how profitability can be increased through the addition of product lines, even if the products are not sold until a later date.

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The company's profitability can appear better if more units are produced, even if they are not sold, because absorption costing can appear to improve operating income regardless of sales. When we increase the level of production and we are using the absorption (full) ...

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