Shira Honig, the chief financial officer of Silicon Valley Computer, is an enthusiastic advocate of just-in-time production. The SVC Keyboard Division that produces keyboards for personal computers has made dramatic improvements in its operations by a highly successful JIT implementation. The Keyboard Division president now wants to adopt backflush costing. Honig discusses the backflush costing proposal with Ralph Strong, the controller of SVC. Strong is totally opposed to backflush costing. He argues that it will open up “Pandora’s box” as regards allowing division managers to manipulate reported division operating income. A member of Strong’s group outlines the three possible variations of backflush costing shown inExhibits 20-7 and 20-8 (pp. 826–827). Strong notes that none of these three methods track work in process. He asserts that this omission would allow managers to “artificially change” reported operating income by manipulating work-in-process levels. He is especially scathingabout the backflush costing where no entries are made until a sale occurs. He comments: Suppose the Division has already met its target operating income and wants to shift some of this year’s income to next year. Under backflush costing with sale of finished goods as the trigger point, the Division will have an incentive to not make sales this year of goods produced this year. This is a bizarre incentive. I rest my case about why we should stay with a job-costing system using sequential tracking. Strong concludes that as long as reported accounting numbers are central to SVC’s performance and bonus reviews, backflush costing should never be adopted.
REQUIRED
1. What factors should SVC consider in deciding whether to adopt a version of backflush costing?
2. Are Strong’s concerns about income manipulation sufficiently important for SVC to not adopt backflush costing?
3. What other ways has SVC to motivate managers to not “artificially change” reported income?