Landau Company
STRATEGIC OPTIONS
• Propose the change in income statement presentation to variable
costing system.
• Propose the keeping of full cost system.
Propose the change in income statement
presentation to variable costing system.
ADVANTAGES
This will enhance the company’s efforts in controlling the variable
aspects of manufacturing.
This method will also prove to be conservative since costs will be
expensed when incurred thus, revenue will be reduced by the expenses
which were incurred during the month.
Propose the change in income statement
presentation to variable costing system.
DISADVANTAGES
However, this system will prove to be less effective if the company
moves from labor intensive to capital intensive manufacturing where
basically majority of the part of operations will be overhead.
Moreover, when sales price is computed only to cover variable costs,
there is no provision made for the fixed costs incurred. As seen in areas
of consideration 10, income decreased as compared to the income
when sales prices were computed based on full cost.
Propose the keeping of full cost system.
ADVANTAGES
Sales price decisions based on this system will provide provision for per
unit fixed overhead.
Moreover, full costing is a function of production. Thus, efficiency in
manufacturing can be well watched since any decrease in production as
compared to sales will alarm management since lesser income is
recognized due to increased inventory costs.
Ease in accounting is also an advantage for full costing since in reality,
determining the fixed part of overhead can be burdensome.
Propose the keeping of full cost system.
DISADVANTAGES
However, some departments can increase reported income by building up
inventory. In this way, much of the overhead costs though incurred for a
certain period may be carried out as assets and hidden in the inventory
accounts. Since the company allocates fixed overhead to the finished unit
level in absorption costing, until the company sells a unit, the cost does not
show up as an expense or Cost of Goods Sold.
In terms of managerial decision making, income statements provided using
this method may seem to be inadequate. Since, absorption costing allocates
fixed overhead costs to the unit level, it makes it appear as though additional
units produced add overhead cost, when in fact they are revenue
opportunities.
RECOMMENDATION
The recommended alternative course of action is for Landau Company
to keep using the full cost system. The continuous implementation of
full cost system will be good for Landau Company in the long-run. It
must be taken into consideration that the current situation the
company is facing based on the case is only temporary. Production in
July was below the standard volume because of employee vacations.
Given low production, overhead was under absorbed, causing the
bottom-line income to decrease from June to July. It must be
understood that this is really an effect of using absorption costing. In
the coming months when production is back to normal volume, full
absorption is still the suitable cost system for it best characterize
production compared to variable costing.
