Question

Discuss possible ways for manipulating profits under the absorption costing system and if you find using these techniques ethically acceptable.

Answer 1

Under absorption costing,

the ending inventory and the cost of goods sold includes the fixed manufacturing overheads, leading the financial statements to change with respect to asset, cost and income.

The amounts which are shown on the face of the financial statements are not accurate.

1. They can be altered by changing the value of the closing stock

2. By changing the predetermined overhead absorption rate which is in the discretion of the management, the profits can easily be manipulated.

If they want to show higher profits, they would increase the closing stock by increasing the overhead rate or overhead amount included in the ending inventory. If they want to show lesser profits, they would do the reverse.

These practices are not ethical, they are unethical.