Question

Give a 6 point discussion of the operational and ethical issues related to incorrect product costing. Example, understatement or overstatement of direct labor hours.

Answer 1

Product costing is the process of determining business expenses pertaining the creation of company products. These costs include raw material purchases, worker wages, production transportation costs etc.

Management accountants work inside a company, handling all internal accounting data. These individual often allocate production costs, create management reports and provide support for managerial decisions. Ethical issues can result from managerial accounting activities.

Issues with Product Costing

1.Overproduction

Overproduction occurs when management accountants work in tandem with operational managers. Accountants can select a method that improves operating profits through recording more expenditures as production costs. This lowers period expenses and increases finished goods inventory. Absorption costing is the common method abused during overproduction. Operating managers and management accountants report higher profits by using absorption costing to record fixed costs in final inventory accounts.

2. Asset Replacement

Companies often need to replace assets at some point during business operations. Management accountants often review equipment and make suggestions as to which assets need replacing. Ethical issues arise, however, since new asset will often lower the return on investment a company receives from certain business projects. This occurs because the new asset has a higher cost, automatically reducing the ROI. Management accountants who do not make recommendations based on ROI impact often acts unethically.

3. Conflicting Interests

Accountants typically work for the best interest of the company, not individual managers or executives. A conflict of interest arises when a management accountant can better his personal position by violating this principle. For example, a management accountant who helps operational managers fudge numbers can better his personal position rather than ensuring the best operational capacity for the business. Offering suggestions to improve the company rather than one segment helps reduce conflicts of interest.

4. Short Term focus

Small differences in production techniques create complicated accounting situations where companies have difficulty determining actual production costs in the short term. Compensating for this lack of clarity requires companies to make long-term projections regarding costs over the life of product lines instead of costs leading up to the sale of products.

5.Inaccurate Base Estimate

Inaccurately estimating the number of hours in the allocation base can lead to under-application of manufacturing overhead. Many small businesses use direct labor dollars or direct labor hours as an allocation base. If this basis is overestimated, then the amount of overhead applied per hour will too low and overhead will be under-applied. Small businesses run into this problem in a couple of ways. First, if your company uses direct labor hours or dollars as your allocation basis and your employees are more productive than you initially expect, you will likely use fewer direct labor hours than expected, and overhead will be under-applied.

6. Calculation in advance

In most such situations, product costing takes place in advance of all work actually accomplished. And, typically, good estimating is the difference between turning a profit or booking a loss.For example, if a business budgets $70,000 to be spent on manufacturing overhead and then spends $80,000 on its actual manufacturing overhead, that business has underapplied overhead of $10,000. Underapplied overhead is recorded as a prepaid expense on the balance sheet and then corrected through increasing cost of goods sold at the end of the time period.