This paper presents a summary of and a reaction to the article, Income Inflation: Absorption Costing vs. Variable by Wink and Corradino. The summary covers the main points presented in the article while the reaction shows an interpretation of the article and application of the knowledge learned.
It is established that the article has both primary and secondary subject matter. The major issue presented in the article refers to income inflation case in which accountants apply GAAP based absorption costing relative to internally applied variable costing when a firm produces more inventory compared to sales. For unethical accountants, there are multiple income inflation opportunities, which are linked with the intent to defraud a firm by getting more bonuses. These income inflation opportunities have been linked to more production compared to sales. It emanates from the variation noted between absorption costing and variable costing (Wink and Corradino 49-54). When sales are kept constant, the absorption costing income statement is generated at three various sales levels.
When variable costing for internal purposes are eliminated, managers should be suspicious as the case study demonstrates. In this case, externally provided financials remain the same while the internal reporting techniques are changed ‘insubstantially’ to enhance decision-making. For a keen manager, changes made from variable to absorption costing, irrespective of their magnitude, often lead to substantial change in reported earnings, specifically if unsold inventory is considered too much. The practice is equated to manipulation or creative accounting often applied by unethical managers to earn bonuses. It is noted that constant productions with declines in sales always lead to higher reported earnings when absorption costing is used rather than variable costing.
Other secondary issues explored in the case reflect financial accounting and managerial accounting. For managerial accounting, reports are mainly for internal use, and this explains why Gail was so concerned about slight modification. Conversely, financial accounting for external purposes must capture some accounting standards.
This article also demonstrates that managers should observe ethical responsibilities in their practices. Both Certified Public Accountants and Certified Management Accountants are exposed to meticulous accounting instructions, practices, and ethical awareness, and they can easily detect manipulation of accounting practices. The article also explores differences between variable and fixed costs, organizational business environments, bonuses and their impacts on unethical managers, and effects of inaccurate reporting on subsequent fiscal years.
This article has raised some fundamental issues that many accountants face today. The issue of creative accounting and manipulation of reporting techniques is responsible for most corporate theft involving accountants and managers.
For Robert, the CPA and CMA ethical codes of conduct has equipped him with sufficient knowledge to understand ethical principles expected from accountants and apply them in practice to deter unethical accounting techniques and practices.
This article shows that students or accountants can apply their knowledge of absorption costing and variable costing to identify manipulation of internal reporting techniques. For managers keen on ‘slight modification’ of internal reporting techniques while insisting on standard practices for external reporting, ethical issues arise. Consequently, their juniors who observe meticulous accounting instructions, practices, and ethical awareness should question such practices and report immediately to protect financial performance and standard accounting practices. Information on variable costs and fixed costs for income statements preparation can help accountants to detect unethical practices immediately and review their findings with senior executives.
Wink, Geri B. and Laurie J. Corradino. “Income Inflation: Absorption Costing vs. Variable.” Journal of the International Academy for Case Studies 16.1 (2010): 49-54. Print.