Stellar Packaging Products uses absorption costing to compute additional compens

Question

Stellar Packaging Products uses absorption costing to compute additional compensation eligibility for managers. In December, Stellar Packaging Products’ controller, Robin Simmons, noted that a considerable production overrun was experienced, resulting in increased ending inventories for its major customer, Estrella Coffee Company. Simmons approached Frank Moses, the production manager, regarding these facts. Moses indicated that indeed, the production overrun was deliberate and completed in order that more overhead application would occur in December, and “everyone would make their year-end bonus.”

Would the situation have changed if the company used variable costing as a basis of additional compensation? Why or why not?

Explanation / Answer

Yes, the situation would have been something different if the company had used variable costing as a basis of additional compensation. The reason being the followings:

The production overrun was deliberate done so that more overhead application, the fixed element of the production would be absorbed in December, so that everyone able to make their year-end bonus. Had the additional compensation is based on the variable costing then Simmons would not let the production overrun deliberatedly to cover the fixed overhead costs because under variable costing the fixed overhead cost is not considered for the calculation of bonus.

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