The undesirable buildup of inventory is often due to the short-term incentives of management and their desire to increase their bonuses. Several results that happen when a manager is attempting to build up inventory consist of the following. The managers may decide to reduce the manufacturing of certain products that absorb less fixed manufacturing costs compared to other products produced by the company. “Production of items that absorb the least or lower fixed manufacturing costs may be delayed, resulting in failure to meet promised customer delivery” (Charles, 201 2, p. 11 The manager may overlook keeping up on maintenance in order to continue pushing the output of their department. “Although operating income in this period may increase as a result, future operating income could decrease by a larger amount if repair costs increase and equipment becomes less efficient” (Charles, 2012, p. 311). Include in your assessment how to best set up absorption costing systems to avoid this incentive ND what types of measures and controls should be included to assist in its prevention.
There are steps that can be taken to determine the proper level of inventory, and how to help ensure that this capacity is not being surpassed. The manager needs to have a budget that they have to stick to, thus not allowing them to over spend on supplies to increase their inventory more than seems practical. “For example, the budgeted monthly balance sheets have estimates of the dollar amount of inventories. If actual inventories exceed these dollar mounts, top management can investigate the inventory buildups” (Charles, 2012, p. 311).
Another step to take could be incorporating a carrying charge for inventory in the internal accounting system. This charge doesn’t have to be very much either, just enough that managers realize their money is going to diminish if they try to cheat the system. “For example, the company could assess an inventory carrying charge of 1% per month on the investment tied up in inventory and for spoilage and obsolescence when it evaluates a manager’s performance” (Charles, 2012, p. 11). The company could also look into changing how often they evaluate performance.
Instead of doing these evaluations two or three times a year, giving managers more time to clear out the built up inventory in between evaluations, they could be done monthly or bi-monthly. Having the evaluations more often, managers might be less tempted to overstock their inventories. Lastly, “Include nonofficial as well as financial variables in the measures used to evaluate performance” (Charles, 2012, p. 311). References Charles T. Hormone, Syrians M. Attar, Madhya V. Raja. 2012). Cost Accounting: A Managerial Emphasis.
Retrieved from http://www. Courseware. Com 19781256857778/prosecution#X21udGvybmFsXOJ2ZGvwRmxhc2hSZWFkZXl /egg saWQ90Tc4MT11 Angle Announcement= Grading Rubric Module 3 Assignment – Absorption Costing & Undesirable Incentives Assigned Criteria Point Range Points Earned management to build inventory. 0-6 points. Explained how absorption costing could provide undesirable incentives to management to build inventory 6-Your explanation was detailed and indicates your level of knowledge of these concepts is well developed.
Include in your assessment how to best set up absorption costing systems to avoid this incentive and what types of measures and controls should be included to assist in its prevention. 0-6 points. Adequately explained the proper way to set up a system to avoid the potential of building inventory just to improve performance measures. Included proper control options. 6-lintiest ideas. Word Document in PAP format with at least one reference.