In This Module You Will Have An Opportunity To Demonstrate Y

In this module you will have an opportunity to demonstrate your understanding of Absorption and Variable Closing and their application in the aviation industry

In this module you will have an opportunity to demonstrate your understanding of Absorption and Variable Closing and their application in the aviation industry. For this case study, complete the three requirements below: A supplier of aircraft parts to an aircraft manufacturer has noticed an increase in inventory. As a result of this, will absorption costing or variable costing income be greater for the supplier? Explain why. You are a management analyst for XYZ aircraft manufacturing company. Your company is considering whether to use absorption costing or variable costing for internal financial analysis. Which method would you recommend and why? Refer to Case 8-43 at the end of Chapter 8. Build or use an existing Excel spreadsheet to complete requirements 2, 3, and 4. Comment on the results obtained from these requirements. The spreadsheet must accompany the submission. Demonstrate your ability to correctly calculate the problem and apply creative thinking by analyzing the case and answering these questions. Review the case study section of the syllabus and the Case Study Rubric for guidance and grading criteria.

Paper For Above instruction

Introduction

Understanding the nuances between absorption costing and variable costing is vital in the aviation industry, especially for companies managing substantial inventories and making strategic internal decisions. These two costing methods influence the reported profitability and inventory valuation, which directly impact management decisions and financial reporting. This paper explores the implications of increased inventory on absorption and variable costing income statements for an aircraft parts supplier, evaluates the appropriate costing method for internal analysis within XYZ aircraft manufacturing, and analyzes relevant financial data using an Excel spreadsheet to support decision-making.

Comparison Between Absorption and Variable Costing

Absorption costing, also known as full costing, allocates all manufacturing costs—both fixed and variable—to products. This means that inventory on the balance sheet includes both direct costs (direct materials, direct labor) and a proportionate share of manufacturing overheads, including fixed costs. In contrast, variable costing accounts only for variable manufacturing costs; fixed manufacturing overheads are treated as period costs and expensed in the period incurred.

The primary difference between these methods lies in their effect on financial statements, particularly when inventory levels change. Under absorption costing, increasing inventory levels defer some fixed manufacturing costs in inventory on the balance sheet, leading to higher reported income. Conversely, variable costing treats fixed manufacturing overheads as expenses in the period they are incurred, which means changes in inventory levels do not impact income in the same way.

Impact of Inventory Increase on Income

In the scenario where an aircraft parts supplier notices an increase in inventory, absorption costing would typically show a higher income compared to variable costing. This occurs because some of the fixed manufacturing overhead costs are included in the inventory value and are not expensed in the current period if inventory increases. As a result, the costs allocated to unsold inventory are deferred, often resulting in higher net income under absorption costing.

In contrast, variable costing expenses all fixed manufacturing overheads immediately, regardless of inventory levels. Therefore, if inventory increases, variable costing will generally report lower income relative to absorption costing because no fixed overhead costs are deferred. This difference can lead to significant discrepancies in profit reporting, which has implications for managerial decision-making and financial analysis.

Recommendations for Internal Costing Methods at XYZ

Given the scenario, for internal financial analysis, I recommend using the variable costing method. Variable costing offers clearer insight into the contribution margin and variable costs associated with production, which is essential for decision-making, cost control, and profitability analysis. It enables managers to understand the impact of production volume changes on profitability without the distortion caused by fixed manufacturing overheads being deferred or expensed differently.

Furthermore, variable costing aligns more closely with the principles of contribution margin analysis, allowing managers to assess the impact of incremental changes in sales, production, and costs on profitability. It also facilitates break-even analysis and other managerial tools that are crucial for strategic planning in a manufacturing environment like XYZ aircraft.

On the other hand, while absorption costing conforms to generally accepted accounting principles (GAAP) for external reporting, its reliance on inventory levels can obscure cost behavior and hinder internal decision-making, especially when evaluating operational efficiencies or making short-term decisions.

Use of Excel Spreadsheet and Data Analysis

To substantiate these recommendations, an Excel spreadsheet should be created based on the data provided in Case 8-43. This spreadsheet would include calculations for total costs, unit costs under both costing methods, income statements under each method, and analysis of how changes in inventory levels impact profit.

The analysis would include:

- Calculating the allocated fixed manufacturing overheads per unit,

- Determining income under both costing methods for different inventory scenarios,

- Comparing the results to highlight the discrepancies,

- Discussing the managerial implications of these findings.

These calculations demonstrate the importance of understanding cost behavior and inventory management in strategic planning. For instance, a rise in inventory levels might increase reported profit under absorption costing without reflecting actual operational performance, potentially leading to misguided strategic decisions.

Conclusion

The distinctions between absorption and variable costing are crucial in the aviation industry, where inventory management plays a significant role. Increased inventory levels generally result in higher reported income under absorption costing due to deferred fixed manufacturing overhead costs. For internal decision-making at XYZ aircraft manufacturing, variable costing is recommended because it provides transparent insights into variable costs and contribution margins, facilitating more effective strategic management. Utilizing Excel spreadsheets to analyze the financial impacts of different inventory scenarios reinforces the importance of selecting appropriate costing methods aligned with managerial objectives. Ultimately, understanding the implications of each method enables better financial control, decision-making, and strategic planning within manufacturing environments.

References

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