Harla Industries Case Solution

1. Provide an explanation to the divisional manager why variable and absorption costing systems result in the reporting of different profits using the information shown in Exhibit 1 Under the adoption of variable costing systems or absorption costing systems, different profits, being classified as gross profit and net profit, will be calculated and reported. In the case of Bohemia Industries, adopting variable costing system reported higher gross margin for both July and August than adopting absorption costing, however, the net profit before tax under absorption costing is higher than variable costing in July, unlike August. Variable and absorption costing systems result in the reporting of different profits since they have different

If absorption costing is adopted in the report , the fixed manufacturing included in the analysis in a product cost would lead to a big differences in setting product selling price compared to variable costing. Referring Exhibit 2, using product A51 as an example, the unit gross profit was £320 and the contribution margin is £275, the differences can up to £95. For division managers, the figure of manufacturing fixed overhead is useless, in other words, this will cause distortion in evaluating individual product performance such as supervisory salaries that result from the arbitrary allocation of common cost. Hence, when adopting variable costing, it is necessary for Owen to identify or decide which part of process manufacturing individual products should restructure, expanse or

This would allow the division manager set a higher selling price than variable costing system. The aim of their decision-making is to have profit maximization through each unit product. But absorption costing may lead to inadequate for managerial decision-making.

Secondly, fixed overhead cost may hide in inventory cost. Since company allocated fixed manufacturing overhead on each finished unit in absorption costing, until the company sells a unit, the fixed overhead cost would not neither be record as expense nor show in cost of good sold. That, if the company does not sell the entirely finished unit in the current period, fixed overhead incurred would be recorded as an asset in the current accounting period. This leads to an increase in value of inventory, instead of separating as a cost, profits may be manipulated if the manager accumulate and stock up the