FDP Company has been performing below the analysts’ earnings expectation, and the management must either increase production or reduce the prices of items, which would improve sales. Although the latter might raise the firm’s revenue, it may lower its income, therefore, using the former approach would be the most appropriate move towards increasing FDP’s reported profit. Company managers use several costing techniques such as the ABC, marginal, and absorption costing methods to create their income statements (Moisello and Mella 203). However, the most used system is full-costing because it absorbs all the expenses in the manufacturing process.
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Gary Price should understand that in the absorption costing system, fixed costs remain the same when the production units change, therefore, the more the items manufactured, the lower the fixed cost per unit. As a result, total expenses of producing goods reduce, leading to an increase in the firm’s income. Safiuddin claims that under the full-costing method, “the higher ending inventory gives rise to lower cost of goods sold and thus higher profit” (17). For this reason, the change in the manufactured units influences the absorption costing profits. Therefore, the management can increase the net operating income by producing several items even if they do not sell them.
If FDP’s management uses the full-costing method to produce several home security products and increase its reported profit, there will be an ethical concern. Both the firm’s directors and stockholders might not get an accurate picture of the income statement. For instance, the marketing department may misrepresent the cost they used to promote the company’s products if they realize that the net operating income increases whether the firm sells items or not. In essence, the administrators use absorption costing to help their companies attain short-term budgets, but in the long-run, they make losses.
In summary, company administrators can manipulate its income statement to reflect wrong figures to the directors and stockholders. In most cases, managers use the absorption costing method to skew the picture of their organization’s profits. Therefore, this technique might not be beneficial to experts when analyzing a company’s financial performance. In brief, institutional managers should avoid using the absorption costing method whenever they want to enhance their organization’s financial efficacy.
Moisello, Anna Maria, and Piero Mella. “Matching Revenues and Costs: The Counter-Intuitive Rationality of Direct Costing.” International Journal of Business and Management, vol. 15, no. 1, 2020, pp. 202-222.
Safiuddin, Mohammad. “Creative Accounting Practices by Bangladeshi Companies: A Study on Recent Share Market Crisis in Bangladesh.” Australian Academy of Accounting and Finance Review, vol. 4, no. 1, 2018, pp. 15-21.