Week 3 – Assignment
Instructor – Donald Frey
January 25, 2015
Week 3 – Assignment
Explain how absorption costing could provide undesirable incentives to management to build inventory. One of the big factors behind the motivation to provide undesirable incentives to management to build up inventory is that management could get a bonus depending upon the absorption costing operating income. This can cause management to push to increase ways to get their bonus larger. Producing more units for inventory will help to absorb any fixed manufacturing costs, thus increasing operating income. The undesirable buildup of inventory is often due to the short-term incentives of management and their desire to increase their bonuses. Several results that happen when a manager is attempting to build up inventory consist of the following. The managers may decide to reduce the manufacturing of certain products that absorb less fixed manufacturing costs compared to other products produced by the company. ”Production of items that absorb the least or lower fixed manufacturing costs may be delayed, resulting in failure to meet promised customer delivery” (Charles, 2012, p.311). The manager may overlook keeping up on maintenance in order to continue pushing the output of their department. “Although operating income in this period may increase as a result, future operating income could decrease by a larger amount if repair costs increase and equipment becomes less efficient” (Charles, 2012, p.311). Include in your assessment how to best set up absorption costing systems to avoid this incentive and what types of measures and controls should be included to assist in its prevention. There are steps that can be taken to determine the proper level of inventory, and how to help ensure that this capacity is not being surpassed. The manager needs to have a budget that they have to stick to, thus not allowing them to over spend on supplies to...
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