• In this case, would it be better to use the variable or absorption costing method, and why? In this case, it would be better to use the absorption method because this method incorporates only the overhead that is allocated to the 80,000 units sold. The variable method counts fixed overhead as a period expense, meaning that the fixed overhead for this period is calculated on the basis of the 95,000 units produced, if the absorption method is used. The absorption method only calculates fixed overhead on the basis of the 80,000 units that were sold. This provides management with a more accurate picture of the profitability of the fishing lures. Thus, the absorption costing method is optimal.
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• What are the benefits of the two methods?
Under absorption costing system, the product cost consists of all variable as well as all fixed manufacturing costs.. But when variable costing system is used, the fixed cost (both manufacturing and non-manufacturing) is treated as a period cost and therefore is not included in the product cost. The ability to provide accurate information to management about product costs is the main benefit of the absorption method. The variable method is beneficial because it provides an output (net income) that is closer to the cash flow of the business. This is useful in particular for businesses that might be short on cash flow. Further, the variable costing method provides management with a clearer picture of the effect that fixed costs have on the total profitability of the company (AFM, 2012).
• Which method would lead to the best decision when a competitor is submitting a lower bid for your product?
Absorption costing is particularly useful for firms that do not sell all of their manufactured products during the accounting period, as is the case with Polk. Under absorption costing, the cost of a good is not shown until the good has been sold (Johnston, 2013). This can be a disadvantage if a portion of the goods produced are ultimately not sold, as management would still have to know the cost of those goods.