Headgear Inc

1019 Words Feb 15th, 2013 5 Pages
18-2 Full Versus Variable Costing and Ethical Issues
HeadGear, Inc is a small manufacturer of headphones for use in commercial and personal applications. The HeadGear headphones are known for their outstanding sound quality and light weight, which makes them highly desirable especially in the commercial market for telemarketing firms and similar communication applications, despite the relatively high price. Although demand has grown steadily, profits have grown much more slowly, and John Hurley, the CEO, suspects productivity is falling, and costs are rising out of hand. John is concerned that the decline in profit growth will affect the stock price of the company and inhibit the firm's efforts to raise new investment capital, which will
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No, the COO is not due a bonus. The reason the profits seem higher under absorption costing is that there are substantial fixed costs of the period that were capitalized because production was so much higher than sales. The fixed costs is trapped on the balance sheet and will be expensed when the items are sold. See reconciliation in Excel for a visual on this.
4. Identify and explain any important ethical issues you see in this case.
In determining the fixed costs per unit for the period for absorption costing (not needed for variable costing since the entire fixed cost is expensed as a cost of the month, not a cost of units), you spread the fixed costs across all the units made. Since production was increased substantially, the fixed cost per unit was reduced:
Fixed manufacturing cost per unit: at 140,000 units $ 13.71 at 175,000 units $ 10.97
This gives the illusion of lower cost of goods sold (and thus higher profits) but it is, in fact, just a temporary capitalizing of the fixed manufacturing costs due to inventory build up.
While building inventories does "trap" fixed costs on the balance sheet, pressuring managers to improve profits gives them an incentive to build inventories to spread the fixed costs thinner and make COGS smaller per unit. This is not ethical. Building inventories in order to improve a profit computation is not profession or ethical but the pressure to perform

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