Absorption approach is constructive for external reporting. It does not provide the competitors with too much information which they can use to their advantage such as the product cost, the material costs, the labor costs and others…
These two important measures of profitability show that the company has made remarkable progress over the nest quarter signifying increased efficiency and effectiveness.
However, this is not the case. The statements prepared under the contribution margin rules show that the contribution margin has not improved between the two quarters. The statement prepared implied the company has contribution margin of 52% in the both the quarters, as seen in figure 5, implying that there has no increase in efficiency of controlling variable costs. Therefore, the profit net profit margin under the contribution margin statement remains 14% in both quarters. The increase in the net income under the absorption id due to the allocation of the fixed costs over a greater number of units produced. Mr. Rozen has increased the production levels from 25,000 units to 50,000 units. This has reduced the allocation of fixed costs from $24 in first quarter to $12 in second quarter. Thus the cost of goods sold has decreased by $300,000 which has increased the gross margins and the net margin. Can you make any suggestions for reporting in the future? Absorption approach is constructive for external reporting. It does not provide the competitors with too much information which they can use to their advantage such as the product cost, the material costs, the labor costs and others. Similarly, this approach considers the costs to the finished inventory as an asset on a balance sheet until it is sold. Therefore, this helps the company to improve its metrics for external stakeholders. Likewise, the Generally Accepted Accounting Principles, or GAAP, requires the publicly held companies to prepare their statements under the absorption approach. (Taylor, 2010) However, for internal users and decision-making, contribution margin approach to income statement is quite useful. Variable costing allows the internal users to understand the product cost of unit which will allow them to decrease variances between actual and budgeted amounts. This helps in controlling costs and overall profitability of the company. With this approach, the managers can make better decisions in a fluctuation sales environment and helps them to accurate the cost of productions for future periods. Likewise, this approach helps to observe an impact of each and every product on the overall profitability of the company. Some products are better absorbers of fixed costs and increase the earnings of the company. Therefore, an adequate decision can be made regarding the discontinuation of product which will least affect the earnings. (Scott, 2012) Do you think Mr. Rosen should be seriously considered for the CEO position? Why or why not? Mr. Rozen has based his decision to increase the production on inadequate information. He has not pondered hard over the impact of his decision on the company’s operations and profitability. With the increase in production, Mr. Rozen only allowed for a better allocation of the fixed costs over a larger quantity of units. This only allowed for the costs to be temporarily seen as assts on the balance sheet in the form of inventory. However, Mr. Rozen must understand that the huge amount of inventory that has been created will need to managed and properly maintained over the nest quarter for the sales in future. This will increase inventory handling costs and storage costs that will have ...
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