Question: *quick reading below*

1. Consider the following simplified example. Ford has quarterly fixed costs of $1,200,000 and expected sales of 100 units. Variable costs are $15,000 per unit. If Ford produces and sells 100 units during the quarter, what is thetotal cost per unit sold?

2. Using the same example from #18 above, if Ford produces 200 units and sells 100 units during the quarter, what is thetotal cost per unit sold? Explain why your answer is different from your answer in #18

MANAGEMENT ACCOUNTING February 2, 2012 CFO amos Why the Big Three Put Too Many Cars on the Lot Ford, General Motors, and Chrysler used "absorption conting to make themselves look more profitable, researchers say. But the practice can be costly, and other companies may want to think twice before they follow ulit. Murielle Segarra Follow on Google+ It's no secret that in the years leading up to 2008, the Big Thne automakers - Font, General Motors, and Chrysler were producing above market demand. But researchers say they know why the automakers did it, and they are warning other companies to avoid the same temptation. To boost profits and keep up with short-term incentives, the automakes used an accounting trick, overproducing while absorption conting." according to professoes from Michigan State University who wote a study on the topic that was recognised this January for its contribution to accounting by the American Institute of CPAs and other groups. Ultimately, the practice hurt the automakers, tacking on advertising and inventory holding costs and posibly causing a decline in brand image, the remarchers say. From 2005 to 2006, long before GM and Chrysler filed for bankruptcy and appealed for federal aid, the automakers had abundant excom capacity. They could make more cars with their resources than consumers were willing to buy. They also had high fived costs including leases on factories and labor contracts that prevented them from laying off workers when demand was low, says Karen Sedatole, associate professor of accounting at MSU and a co-author of the study To take advantage of these factors, the Big Three produced above market demand while using absorption costing - a technique that allows companies to calculate the cost of making a product by dividing total costs by the total number of products made, Sedatole ways thing this methol, the cars the automakers made absorbed all manufacturing costs, including the cost of paying went on idle factories Because this method considers all fixed costs as part of the cost of goods sold, it gives companies an incentive to spend that cont among more products to make the cost-per-product appear lower. If this company has excess capacity, produces all the products it can, and sells up to demand, its cost of yoods sold will be lower than it would if the company had only produced up to demand. This lower cost boosts profits on the income statement. Instead of writing off the cost of these ide plants as an expense, companies shift it to the balance sheet an inventory Say fixed costs for a given factory are $100, and that the factory can make 50 cars Consumers, however, demand only 10. Under absorption costing, if the company makes all go cars, its cont-per-car is 32. If it makes only up to demand, or 10 cars, the cost per car is $10. Although each car adds variable costs for steel and other parts, if those costs are low, the company still has an incentive to make more cars to keep the cost-per-car down. If the company makes all so cars but can only sell ao, its cost of goods sold will appear on its income statement as to cars at sa per car, or $20, plus variablo conts. The cost of making the other cars will land on the balance sheet av ending inventory If on the other hand, the company makes just ao cars, its whole overhead cost of $100 will fall on its income statement, raising its cost of goods sold and lowering profits. Companies that everproduce to avoid the latter senario are in a way, managing earings upward by trapping costs on the balance sheet as inventory, so they won't hit the income statement, "Sedatole says. Absorption costing is bepal. FASB Statement 151 allows companies to use the practice for "normalexes capacity and to expense "abnormal" excess capacity. But it doesn't clearly define what's normal, leaving room for companies to overproduce in order to lower unit cost But business leaders should think twice before letting this accounting method influence their production decisions, Sedatole says, Even though they can make their companies appear more profitable in the short term by concealing excess capacity costs on the balance sheet, holding so much excess inventory could be costly, she says. "When (the automakers) couldn't sell the cars, they would sit on the lot. They'd have to go in and replace the tires, and there were costs associated with that," Sedatole says. The companies also had to pay to advertise their ears, often at discounted prices. And by making their cars cheaper and more readily available, they may have turned off potential customers, she adds. "If you see a $12,000 car in a TV ad is being auctioned off for $6,000 at your local dealer, that affects your image of that vehicle." says Secatole. This effect on brand image is difficult to quantify, but the researchers correlated 1% of rebate with a 2% decline in appeal in the J.D. Power Automotive Performance Execution and Layout (APEAL.) Index. The Central Lesson Some might argue that it's good strategy for a company already obligated to pay rent and salaries on its factories to make products up to its capacity. An economist would say as long as I could sell the car for more than its variable cost, I'm better off selling it." Sedatole says. But that's a very, very short-term way of thinking." because it neglects the costs that come with having a high volume of excess inventory The central lesson? Companies shouldn't use their financial reporting methods to make internal decisions, says Ranjani Krishnan, MSU professor of accounting and a co-author of the study. "The objective of financial accounting is to provide information for stakeholders that are external to the company," Krishnan says. "But that is not adequate from the perspective of internal decision- makers. Managerial accounting needs to focus on the best way to provide information that will lead to strategic economic decisions." Using absorption costing to monitor efficiency can lead companies to make poor production decisions, Krishnan says. A company that does this could seem to be growing less efficient when demand decreases. If a factory makes fewer cars this year than last year, for instance, its cost-per-car will look higher, and it may then overproduce in order to present itself more favorably to shareholders, consumers, and analysts. Instead, Krishnan suggests, companies should write off the cost of excess capacity as an expense on their internal income statements, a practice that may help give them perspective. Another way to avoid overproduction: companies can change the way they pay executives. Like many companies, the automakers put their managers under pressure to deliver in the short term by structuring executive-compensation incentives around metrics like labor hours-per-vehicle, which the auto industry's Harbour Report uses to compare companies. With fixed labor hours, the only way to look more efficient under this measure is to produce more cars. "A lot of this behavior was frankly driven by greed," Krishnan says. "If you look at the type of managerial incentives they had during the time of our study, the executive committee deliberations, it was all about meeting short-term quarterly traffic numbers or meeting analysts forecasts so that they could got their bonuses." Instead, companies have to look at performance from a more holistic perspective, and not just look at financial numbers like net margin or profit, or return on investment, but also at things like customer satisfaction or brand image, things which may be a little bit more difficult to measure because they're not as quantifiable." Sedatole and Krishnan co-authored the study with Alexander Brggen, an associate professor at Maastricht University in the Netherlands RELATED ARTICLES MANAGEMENT ACCOUNTING Capex, Inventory Spend Squeeze Cash: Study ACCOUNTING & TAX Private Companies Gain GAAP Exceptions