EXECUTIVE SUMMARY In the fast-paced World, companies are geared towards maintaining the stability of financial structure of the business to gain profit. In this case, Income Statement states that July sales had substantially increased than June but income in July was lower over June. This dilemma was cited by Terry Silver the new marketing vice-president of Landau Company. Over 38 years, company conveniently used Full Costing System for their Income Statement.
The suggested shift in the system to Variable Costing System was considered by Meredith Wilcox Company’s chief accountant after attending the meeting of the members of the group of Institute of Management Accountants. She recast the Income Statement and presented the same to Silver as areas of consideration. The latter system, would eliminate the time consuming efforts of allocating fixed overhead to individual products & segregated cost of materials, direct labor and variable overhead from fixed overhead costs, Silver said.
However, according to Jamie [the treasurer] system suggests lack of control over long-run costs that can bankrupt the company. The President and Treasurer shared the same light on the matter. Whereas proposal using Variable Costing approach was well thought-out and exceeds the idea that the system under variable costing, the profit for a period is not affected by changes in inventories. Other things remaining the same (i. e. selling prices, costs, sales mix, etc. ), profits move in the same direction as sales when variable costing is in use.
In this case, Variable Costing System approach was recommended to answer the need of internal people to access the financial stability of the said company. The impact of fixed costs on profits is emphasized under the variable costing and contribution approach. The total amount of fixed costs appears explicitly on the income statement. Under absorption, the fixed costs are mingled together with the variable costs and are buried in cost of goods sold and in ending inventories. Thus, It’s provide better information hence is a useful managerial decision making tool.
It concentrates on the controllable aspects of business by separating fixed and variable costs. The effect of production and sales policies is more clearly seen and understood. Problem Statement What costing system should Landau Company adopt to best represent the company’s Income Statement Objectives * To adopt the most effective costing system that would reflect the company’s profitability. * To identify the advantages and disadvantages of the chosen costing system. * To enhance help management’s control effort.
Areas of Consideration * The significant increase of July sales, yet income was lower than in June. * Lack of control over the long-run costs that can bankrupt a company. * Product margins for the month of June and July. * Proposal of new costing system Alternative Courses of Action 1. Variable Costing System Advantages: * Eliminates time consuming efforts of allocating fixed overhead to individual products. * Useful in comparing the profitability of the individual product. * Avoids complexities associated with manufacturing cost. Removes fixed manufacturing overhead and treat it as period cost * Help managers understand the manufacturing costs being incurred. * Very useful in making decision and internal reports * Helps prevent overproduction. Disadvantages * Selling the products at their usual mark up over variable costing * Volume variances will not be reflected since no fixed overhead is applied to products. * Not accepted for external reporting * If fixed cost is not treated as cost of product, lower selling price is set. 2. Full Costing System Advantages: It recognizes the importance of fixed cost in production. * Used in external reporting * When production remains constant but sales fluctuate this system will show less fluctuation in net profit. Disadvantages: * As full costing emphasized on total cost namely both variable and fixed, it is not so useful for management to use to make decision, planning and control. * As the manager’s emphasis is on total cost, the cost volume profit relationship is ignored. Recommendation Our group recommends that Landau Company should adopt the accounting system proposed by Terry Silver.
We believe that variable costing is the most efficient system, because this system reflects the actual status of the company in terms of profitability, it is useful in comparing the profitability of the individual products, and it eliminates the time consuming efforts of allocating the fixed overhead to individual products. The said system provides relevant information that is useful in making managerial decisions and it will help the managers of Landau Company understand how production and sales affect the income generated for a certain period.