Absorption Costing Discussion.
Absorption Costing Discussion.
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Using the attachment, provide a summary and a reaction to the article. The summary should be approximately 250 words, and the reaction should be approximately 150 words. The summary should describe the major points of the article, and the reaction should demonstrate your interpretation of the article and how you can apply that knowledge. ACC650O500 Absorption Costing Discussion
Please include proper citations in your discussion post. Points will be deducted if proper citations are not used.
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Absorption Costing and Fixed Factors of Production Lawrence A. Gordon and Henry Cook, Jr. D R. FEKRAT’S article “The Conceptual Foundations of Absorption Costing,” appearing in the April, 1972 issue of T H E ACCOUNTING REVIEW, is at least thought provoking and at most partially correct.^ In this article, he sets forth an argument for absorption costing versus variable costing. His argument narrows down to the differentiation between fixed factors being indivisible as to acquisition as opposed to use. “To be sure, following Maxwell, we can drop the assumption of the complete indivisibility of the fixed factor by distinguishing between indivisibility in acquisition and indivisibility in use. According to Professor Fekrat, fixed factors are fixed as to the available quantum of services but are divisible as to the use of these services. In other words, even though the fixed factors are indivisible as to^ acquisition, the flow of services they will render are divisible over their useful life. On the other hand, traditional economic theory treats fixed factors as being fixed as to time and not divisible as to use, thereby generating the familiar nonlinear total product and variable cost curves derived from the two factor production function. In essence. Professor Fekrat is saying that since fixed factors are fixed as to service, not time, their use takes on the nature of being a variable cost with respect 128 to production. If production slows down, or halts, then the fixed factor services are slowed or halted, and vice-versa. Therefore, he argues that fixed factors are a function of production and must be charged accordingly for both inventory and decision making purposes. However, by defining the fixed factors’ value as equal to the discounted flow of services. tt (1 + i)’ he errs by not realizing that the nature of this definition places a time value on the services.^’* Each adjustment to the planned production life horizon of a fixed factor must change the present value of its total service contributions, thus changing the asset’s value and its economic depreciation. Consequently, every fixed asset’s value is at least partly a function of time.^ ‘ M. Ali Fekrat, “The Conceptual Foundations of Absorption Costing.” THE ACCOUNTING REVIEW (April 1972), pp. 351-5. 2 Ibid., p. 353. ‘ This definition of an asset is often referred to as the true economic value. * This is true even if we assume the price level is constant. ^ “Wasting assets” come closest to being strictly a function of use. However, even these assets are partly a function of time for the reason stated above. Lawrence A. Gordon is Assistant Professor of Accounting at McGill University and Henry Cook, Jr. is Instructor of Accounting at Clarkson College of Technology. ACC650O500 Absorption Costing Discussion
Gordon and Cook: Absorption Costing—Comment This means that if its services are deferred, then a part of its value is lost. Also, if the fixed asset is used at an accelerated rate, then its value would be increased. Therefore, if a fixed factor is divisible as to use, its value is both a function of use and time. That portion which is a function of time should be treated as a period cost. Furthermore, greater production in the early life of an asset has at least two advantages. First, the present value of earlier service contributions is greater. Second, the greater production now might never be used in the future since rapid technological advances might make deferring production economically unfeasible. On the other hand, we agree with Dr. Fekrat in that the portion of the asset which is a function of use should be treated in the same manner as are variable costs. However, we would argue that, for most fixed factors, production capabilities are only slightly fixed as to use because of maintenance and repairs, but are fixed as to time because of obsolescence.^ Therefore, the greatest share of these fixed factors should be treated as period costs over its useful “time life” as determined by obsolescence projections. The amount 129 charged to each period would theoretically be the economic depreciation, of the asset’s value, not attributable to use. Describing the fixed factor’s value as a function of time and use could theoretically be derived with the aid of regression analysis. A model of this nature would have to include other variables such as obsolescence, repairs, and maintenance. In conclusion, although Dr. Fekrat’s argument is particularly appealing, since under his plan short-run decisions would coincide with long-run decisions, the solution is not that simple. Since fixed factors are primarily fixed with respect to time, and at most partly a function of use, then at most only a part of the value of a fixed factor should be charged to production based on its divisibility of use. Thus, the argument for absorption costing for decision making purposes is not valid. In fact, the ideal would be a variable cost system that considers as a variable cost the portion of fixed factors which is a function of use. « For decision making purposes, if production is accelerated then the present value of the future maintenance and repair costs must be compared to the present value of the additional contributions.