COST BEHAVIOR

Cost Behavior Modular Case

Cost Behavior Modular Case

Summary of Calculations

The following table presents summaries of income for both quarters using absorption costing and variable costing approaches. The complete calculations are appended at the end of this paper.

Absorption Costing Quarter 1 Net operating income $750,000

Variable Costing Quarter 1 Net operating Income $625,000

Absorption Costing Quarter 2 Net operating income $1,325,000

Variable Costing Quarter 2 Net operating Income $1,875,000

The cost of production per unit is obtained by dividing total costs of production by the total units manufactured. The following table presents production costs for both approaches for quarter 1.

Per Unit Production Cost Comparison of two approach for Quarter 1

Approach

Production Cost

Total Units

Per Unit Cost

Absorption Income Statement

$2,187,000

25000

$87.48

Contribution Margin Income Statement

$1,875,000

25000

$75.00

Per Unit Production Cost Comparison of two approach for Quarter 2

Approach

Production Cost

Total Units

Per Unit Cost

Absorption Income Statement

$2,500,000

25000

$100.00

Contribution Margin Income Statement

$1,250,000

25000

$50.00

Performance and its Assessment

Under the absorption costing approach, Ronald could improve his financial performance from $750,000 to $1,325,000. This indicates an increase of $525,000 in net income. Under the variable costing approach, this improvement is even more positive. Income improves from $625,000 (Q1) to $1,875,000. This increase is attributed to increase in the value of ending inventory.

Suggestions for Reporting

In reporting the financial performance, a company must take into account the true picture of its operations. Unfortunately, however, Ystad Industries puts up much in inventory than it usually sells. This inflates or exaggerates its profits. From piling up a large amount of inventory at the year end, a company incurs substantial costs with respects to maintenance, insurance, and theft (Shim & Siegel 2000). I suggest Roland to incorporate some better inventory models like EOQ so that it can save on its inventory. Merely showing good inventories at the yearend only adds a potentially unrealizable portion of income (Izhar & Hontoir 2001). If the company is not able to make sales as it forecasted, it will eventually end up in losses.

Roland's suitability for the CEO position

I do not think Roland qualifies enough for the CEO seat. The primary reason for this is that he does not seem to be well familiarized with skills and strategies required to keep up the operations. All he does is forecasting 'too ideal' incomes from using an approach which is not prudent at all. Although he might improve the costing approach by using variable costing strategy, this would not help his company in the long run. Therefore, Ronald must familiarize himself with the basics of financial reporting to prove his aptitude for the CEO position.

Shortcomings of the absorption approach

Under the absorption costing approach, a company uses a deceptively simple pricing strategy. A company merely computes the product cost of each unit, makes a decision for the profit or margin, and determines its price. The company does not take into account the marketing or the demand sides of the price that will be the ultimate determinants of profits. Although the absorption costing approach rests on the unit sales forecasts, the demand ...