An Extreme Version of Variable Costing
Eli Goldratt advocates that all manufacturing costs other than materials be treated as operating expenses for the period.Periodic profits would be calculated as:
Operating data for last year are
There is no beginning inventory.
Required:
a.Compare profits under absorption costing and Goldratt's method.
b.Evaluate Goldratt's proposal.

Question

An Extreme Version of Variable Costing
Eli Goldratt advocates that all manufacturing costs other than materials be treated as operating expenses for the period.Periodic profits would be calculated as:
  Operating data for last year are
  There is no beginning inventory.
Required:
a.Compare profits under absorption costing and Goldratt's method.
b.Evaluate Goldratt's proposal.

Quizplus · Accepted Answer

The Answer is Solution to An Extreme Version of Variable Costing (20 minutes)
a.The following table shows that profits are lower by $1,460 if computed using Goldratt's suggestion:

Solution to An Extreme Version of Variable Costing (20 minutes) a.The following table shows that profits are lower by $1,460 if computed using Goldratt's suggestion: b.Goldratt's proposal extends variable costing to the writing off of direct labor and variable overhead cost when incurred.The proposal creates strong incentives against building inventories.Labor and overhead costs in inventories are written off against earnings instead of being capitalized into inventory.Thus,profits and assets are lower when inventories are added compared to full absorption costing.Since product costs contain labor and overhead,calculating product costs using only materials understates true product costs.

b.Goldratt's proposal extends variable costing to the writing off of direct labor and variable overhead cost when incurred.The proposal creates strong incentives against building inventories.Labor and overhead costs in inventories are written off against earnings instead of being capitalized into inventory.Thus,profits and assets are lower when inventories are added compared to full absorption costing.Since product costs contain labor and overhead,calculating product costs using only materials understates true product costs.