Decision-making problems that could occur when using absorption costing include which of the following? (More than one answer may be correct.)

BlackTom Analysis

Question

Decision-making problems that could occur when using absorption costing include which of the following? (More than one answer may be correct.)

BlackTom Analysis

BlackTom AI · Accepted Answer

Here is a structured analysis of each option related to absorption costing and the decision-making problems it can create.

Option 1: 'Assuming fixed costs will not change with changes in production' This statement touches on a common pitfall when interpreting fixed costs under absorption costing. In absorption costing, fixed manufacturing overhead is allocated to units produced, so the product cost per unit can fluctuate as production volume changes. While the total fixed costs for the period remain the same, the per-unit fixed cost changes with the level of production. Treating fixed costs as if they do not change with production ignores the mechanics of overhead absorption and can lead to inaccurate cost information for decision making. Therefore, this assumption can cause flawed analyses, pricing, and production decisions because it misstates how costs behave as volume varies.

Option 2: 'Inappropriate pricing decisions' Absorption costing allocates fixed overhead to products, which can obscure the true incremental cost of producing an additional unit, especially if output levels swing. Managers might price products based on allocated overhead rather than true marginal costs, leading to prices that are too high or too low relative to the actual contribution margin. This is a well-documented risk of absorption costing that can distort pricing decisions in the short term, product mix choices, and profitability assessments.

Option 3: 'Dropping profitable products' When fixed overhead is allocated across all products, some products may appear unprofitable in the short term due to the way overhead is distributed. Managers might decide to drop those products based on allocated profits rather than true incremental profits, causing the company to lose profitable offerings or overall long-run profitability. This is another recognized decision-making hazard associated with absorption costing, particularly in mixed product environments where fixed costs are heavy or unevenly allocated.

In summary, each option highlights a way absorption costing can mislead decisions: (1) mischaracterizing fixed cost behavior with production changes, (2) causing inappropriate pricing due to overhead allocation affecting perceived costs, and (3) prompting the dropping of profitable products because of reported profitability tied to fixed-cost allocation rather than true incremental profitability.

Decision-making problems that could occur when using absorption costing include which of the following? (More than one answer may be correct.) BlackTom Analysis

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