8-1

CHAPTER 8
ABSORPTION AND VARIABLE COSTING, AND
INVENTORY MANAGEMENT
DISCUSSION QUESTIONS
1. The only difference between absorption
costing and variable costing is the way in
which fixed overhead costs are assigned.
Under variable costing, fixed overhead is a
period cost; under absorption costing, it is a
product cost.
2. Absorption-costing income is greater because
some of the periods fixed overhead is placed
in inventory and not recognized as part of
Cost of Goods Sold on the absorption-costing
income statement.
3. A segment is any subunit of sufficient
importance to warrant production of
performance reports.
4. Contribution margin is the amount available to
cover fixed expenses and provide for profit.
Segment margin is the amount available to
cover common fixed expenses and provide for
profit. Contribution margin is the difference
between revenues and variable expenses.
Segment margin is contribution margin less
direct fixed expenses.
5. No, the purchase price is not part of the
fundamental EOQ formula. However, the
potential for quantity discounts may be
considered by management in deciding
whether or not to order the EOQ amount. For
example, the company may order more than
the EOQ amount if the quantity discount is
larger than the additional carrying cost.
6. Ordering costs are the costs of placing and
receiving an order. Examples include clerical
costs, documents, insurance, and unloading.
Carrying costs are the costs of carrying
inventory. Examples include insurance, taxes,
handling costs, and the opportunity cost of
capital tied up in inventory.
7. Stockout costs are the costs of insufficient
inventory (e.g., lost sales and interrupted
production).
8. Reasons for carrying inventory include the
following: (a) to balance setup and carrying
costs, (b) to satisfy customer demand, (c) to
avoid shutting down manufacturing facilities,
(d) to take advantage of discounts, and (e) to
hedge against future price increases.
9. If carrying costs increase, that implies that
fewer orders are placed. However, the
company still needs the annual demand for
the part. So fewer orders imply a larger
number of parts ordered. This increases
carrying costs.
10. The economic order quantity is the amount
that should be ordered so as to minimize the
sum of ordering and carrying costs.
11. Safety stock is the difference between
maximum demand and average demand,
multiplied by the lead time. By reordering
whenever the inventory level hits the safety
stock point, a company is ensured of always
having sufficient inventory on hand to meet
demand
12. JIT minimizes carrying costs by driving
inventories to insignificant levels. Ordering
costs are minimized by entering into long-term
contracts with suppliers (or driving setup times
to zero).
8-2
MULTIPLE-CHOICE EXERCISES
81 a
82 d
83 a
84 e
85 c
86 b
87 d
88 a
89 c
810 d
811 b
812 d
8-3
CORNERSTONE EXERCISES
Cornerstone Exercise 813
1. Units ending inventory = Units beginning inventory + Units produced Units
sold
= 400 + 12,000 11,200
= 1,200

2. Direct materials $ 25
Direct labor 80
Variable overhead 20
Fixed overhead 30
Unit product cost $155

3. Value of ending inventory = 1,200 $155 = $186,000
Cornerstone Exercise 814
1. Units ending inventory = Units beginning inventory + Units produced Units
sold
= 400 + 12,000 11,200
= 1,200

2. Direct materials $ 25
Direct labor 80
Variable overhead 20
Unit product cost $125

3. Value of ending inventory = 1,200 $125 = $150,000
8-4
Cornerstone Exercise 815
1. Direct materials $20
Direct labor 14
Variable overhead 3
Fixed overhead 5
Unit COGS $42

Total COGS = $42 7,500 units = $315,000

2. Engers Company
Income Statement Under Absorption Costing
For the Most Recent Year

Sales ($70 7,500) ..................................................................... $ 525,000
Less: Cost of goods sold .......................................................... 315,000
Gross margin ........................................................................ $ 210,000
Less: Selling and administrative expenses ............................. 142,000
Operating income ...................................................................... $ 68,000
Cornerstone Exercise 816
1. Direct materials $20
Direct labor 14
Variable overhead 3
Unit variable COGS $37

Total variable COGS = $37 7,500 units = $277,500

2. Engers Company
Income Statement Under Variable Costing
For the Most Recent Year

Sales ($70 7,500) ................................................ $525,000
Less: Variable cost of goods sold....................... 277,500
C Co on nt tr ri ib bu ut ti io on n margin ........................................ $247,500
Less fixed expense:
Overhead .......................................................... $ 40,000
Selling and administrative expenses ............. 142,000 182,000
Operating income ................................................. $ 65,500
8-5
Cornerstone Exercise 817
Fering Nurseries, Inc.
Segmented Income Statement
For the Coming Year

Poinsettias Fruit Trees Total

Sales $1,200,000 $ 3,000,000 $ 4,200,000
Variable cost of goods sold (400,000) (1,000,000) (1,400,000)
Variable selling expense (36,000) (90,000) (126,000)
Contribution margin $ 764,000 $ 1,910,000 $ 2,674,000

Less direct fixed expenses:
Direct fixed overhead (260,000) (200,000) (460,000)
Direct selling and administrative (127,000) (78,000) (205,000)
Segment margin $ 377,000 $ 1,632,000 $ 2,009,000

Less common fixed expenses:
Common fixed overhead (1,475,000)
Common selling and administrative (380,000)
Operating income $ 154,000
Cornerstone Exercise 818
1. Number of orders =
order an in pounds of Number
used pounds of number Annual

=
500
2,500

= 5 orders per year

2. Total ordering cost = Number of orders Cost per order
= 5 orders $4
= $20

3. Total carrying cost = Average number of pounds in inventory
Cost of carrying one pound in inventory
=
2
500
$2
= $500

4. Total inventory-related cost = Total ordering cost + Total carrying cost
= $20 + $500
= $520
8-6
Cornerstone Exercise 819
1. EOQ =
2 D CO
CC


EOQ = 2 4 $2,500/2

= 100 pounds

2. Number of orders =
order an in pounds of Number
used pounds of number Annual

=
100
2,500

= 25 orders per year

3. Total ordering cost = Number of orders Cost per order
= 25 orders $4
= $100

4. Total annual carrying cost under the EOQ policy
= (100/2)/2
= $100

5. Total inventory-related cost = Total ordering cost + Total carrying cost
= $100 + $100
= $200
Cornerstone Exercise 820
Reorder point = Daily usage Lead time
Reorder point = 10 4 days = 40
Cornerstone Exercise 821
1. Safety stock = (Maximum daily usage Average daily usage) Lead time
= (15 10) 4 days
= 20

2. Reorder point = Maximum daily usage Lead time
Reorder point = 15 4 days = 60

Or

Reorder point = (Average daily usage Lead time) + Safety stock
Reorder point = (10 4 days) + 20 = 60
8-7
EXERCISES
Exercise 822
1. Unit direct materials cost =
15,000
$79,500
= $5.30

Unit direct labor cost =
15,000
$105,000
= $7.00

Unit variable overhead cost =
15,000
$15,900
= $1.06

Unit fixed overhead cost =
15,000
$51,000
= $3.40

2. Unit direct materials cost $ 5.30
Unit direct labor cost 7.00
Unit variable overhead cost 1.06
Unit fixed overhead cost 3.40
Absorption cost per unit $16.76

3. Ending inventory in units = 15,000 13,800 = 1,200

4. Absorption-costing ending inventory = $16.76 1,200 = $20,112
Exercise 823
1. Unit direct materials cost $3.80
Unit direct labor cost 3.15
Unit variable overhead cost 0.68
Variable-costing cost per unit $7.63
2. Variable-costing ending inventory = $7.63 (30,000 28,900) = $8,393

8-8
Exercise 824
1. Unit direct materials cost
(
75,000
$615,000
)
$ 8.20
Unit direct labor cost
(
75,000
$105,000
)
1.40
Unit variable overhead cost
(
75,000
$78,750
)
1.05
Unit fixed overhead cost
(
75,000
$270,000
)
3.60
Absorption cost per unit $14.25

2. Unit direct materials cost
(
75,000
$615,000
)
$ 8.20
Unit direct labor cost
(
75,000
$105,000
)
1.40
Unit variable overhead cost
(
75,000
$78,750
)
1.05
Variable cost per unit $ 10.65

3. Absorption-costing ending inventory = $14.25 400 = $5,700

4. Variable-costing ending inventory = $10.65 400 = $4,260
Exercise 825
1. Unit direct materials cost $ 7.50
Unit direct labor cost 2.75
Unit variable overhead cost 3.90
Unit fixed overhead cost 4.50
Absorption cost per unit $18.65

2. Unit direct materials cost $ 7.50
Unit direct labor cost 2.75
Unit variable overhead cost 3.90
Variable cost per unit $14.15

8-9
Exercise 825 (Concluded)
3. Absorption-costing income:
Sales ($30 74,600) .............................................. $2,238,000
Less: Cost of goods sold ($18.65 74,600)........ 1,391,290
Gross margin ................................................... $ 846,710
Less:
Variable selling expense ($2 74,600) .......... $ 149,200
Fixed selling expense ..................................... 56,500
Fixed administrative expense ........................ 213,000 418,700
Operating income ................................................. $ 428,010

4. Variable-costing income:
Sales ($30 74,600) .............................................. $2,238,000
Less variable costs:
Cost of goods sold ($14.15 74,600) ............ $1,055,590
Selling expense ($2 74,600) ......................... 149,200 1,204,790
Contribution margin ............................................. $1,033,210
Less fixed costs:
Fixed overhead ($4.50 80,000) ..................... $ 360,000
Selling and administrative expenses ............. 269,500 629,500
Operating income ................................................. $ 403,710
Exercise 826
1. Direct materials $ 8.00
Direct labor 4.00
Variable overhead 1.50
Fixed overhead 4.15
Absorption-costing unit cost $17.65

2. Direct materials $ 8.00
Direct labor 4.00
Variable overhead 1.50
Variable-costing unit cost $13.50

3. Ending inventory = Beginning inventory + Units produced Units sold
= 0 + 20,000 17,200
= 2,800

4. Absorption-costing ending inventory = $17.65 2,800 = $49,420

5. Variable-costing ending inventory = $13.50 2,800 = $37,800
8-10
Exercise 827
1. Absorption-costing income:
Sales ($32 17,200) .............................................. $550,400
Less: Cost of goods sold ($17.65 17,200)........ 303,580
Gross margin ................................................... $246,820
Less:
Variable selling expense ($3 17,200) .......... $ 51,600
Selling and administrative expenses ............. 24,300 75,900
Operating income ................................................. $170,920

2. Variable-costing income:
Sales ($32 17,200) .............................................. $550,400
Less variable costs:
Cost of goods sold ($13.50 17,200) ............ $232,200
Selling expense ($3 17,200) ......................... 51,600 283,800
Contribution margin ............................................. $266,600
Less fixed costs:
Fixed overhead ($4.15 20,000) ..................... $ 83,000
Selling and administrative expenses ............. 24,300 107,300
Operating income ................................................. $159,300
Exercise 828
1. Units ending inventory = Units beginning inventory + Units produced Units
sold
= 0 + 17,000 14,000 = 3,000 units

2. Absorption costing:
Direct materials $ 35
Direct labor 65
Variable overhead 30
Fixed overhead 20
Unit product cost $150

Value of ending inventory = 3,000 $150 = $450,000

3. Variable costing:
Direct materials $ 35
Direct labor 65
Variable overhead 30
Unit product cost $130

Value of ending inventory = 3,000 $130 = $390,000
8-11
Exercise 828 (Concluded)
4. Sales ($200 14,000) $2,800,000
Less: Cost of goods sold ($150 14,000) 2,100,000
Gross margin $ 700,000
Less: Selling and administrative expenses 200,000
Absorption-costing operating income $ 500,000

5. B&O Cafe Variable-Costing Income Statement

Sales ($200 14,000) $2,800,000
Less: Cost of goods sold ($130 14,000) 1,820,000
Contribution margin $ 980,000
Less fixed expenses:
Fixed overhead ($20 17,000) $340,000
Fixed selling and administrative 200,000 540,000
Variable-costing operating income $ 440,000
Exercise 829
Trendy Inc.
Segmented Income Statement
For the Coming Year

Sweaters Jackets Total

Sales $ 300,000 $ 420,000 $ 720,000
Variable cost of goods sold (180,000) (200,000) (380,000)
Variable selling expense (15,000) (21,000) (36,000)
Contribution margin $ 105,000 $ 199,000 $ 304,000
Less direct fixed expenses:
Direct fixed overhead (25,000) (40,000) (65,000)
Direct selling and administrative (20,000) (50,000) (70,000)
Segment margin $ 60,000 $ 109,000 $ 169,000
Less common fixed expenses:
Common fixed overhead (45,000)
Common selling and administrative (15,000)
Operating income $ 109,000

8-12
Exercise 830
1. Consumer Small Business
Computers Computers

Direct materials $500 $1,800
Direct labor 160 290
Variable overhead 40 75
Variable selling expense 75 70
Total unit variable cost $775 $2,235

No, the unit variable cost does not equal the unit variable product cost. The
unit variable product cost includes direct materials, direct labor, and variable
overhead. The unit variable cost also includes variable selling and
administrative expense.

2. Hill Computers Inc.
Segmented Income Statement
For the Coming Year

Consumer Small Business
Computers Computers Total

Sales $ 62,400,000 $ 276,000,000 $ 338,400,000
Variable cost of goods sold (56,000,000) (259,800,000) (315,800,000)
Variable selling expense (6,000,000) (8,400,000) (14,400,000)
Contribution margin $ 400,000 $ 7,800,000 $ 8,200,000
Less direct fixed expenses:
Direct fixed overhead (120,000) (200,000) (320,000)
Segment margin $ 280,000 $ 7,600,000 $ 7,880,000
Less common fixed expenses:
Common fixed overhead (700,000)
Common selling and
administrative (3,460,000)
Operating income $ 3,720,000
Exercise 831
1. Orders per year =
order per units 400
units 4,000
= 10 orders

2. Total ordering cost = $20 10 = $200

3. Average amount in inventory =
400 + 0
2
= 200 units
Total carrying cost = $4 200 units = $800
8-13
Exercise 831 (Concluded)
4. Total inventory-related cost = Total ordering cost + Total carrying cost
= $200 + $800 = $1,000
Exercise 832
1. EOQ =
2 4,000 $20
$4


=
4
000 , 160


= 200 units

2. Number of orders =
order an in units of Number
used units of number Annual


=
200
4,000


= 20 orders per year

3. Total ordering cost = Number of orders Cost per order
= 20 orders $20
= $400

4. Total carrying cost = Average number of units in inventory Cost of
carrying one unit in inventory

=
2
200
$4

= $400

5. Total inventory-related cost = Total ordering cost + Total carrying cost
= $400 + $400
= $800
8-14
Exercise 833
1. Reorder point without safety stock = Average daily rate Lead time
= 80 3
= 240

2. Safety stock = (Maximum daily rate Average daily rate) Lead time
= (90 80) 3
= 30

3. Reorder point with safety stock = Reorder point without safety stock + Safety
stock
= 240 + 30
= 270

OR

Reorder point with safety stock = Maximum daily usage Lead time
= 90 3
= 270
Exercise 834
1. Reorder point without safety stock = Average daily rate Lead time
= 30 6
= 180

2. Safety stock = (Maximum daily rate Average daily rate) Lead time
= (35 30) 6
= 30

3. Reorder point with safety stock = Reorder point without safety stock + Safety
stock
= 180 + 30
= 210

OR

Reorder point with safety stock = Maximum daily usage Lead time
= 35 6
= 210

8-15
PROBLEMS
Problem 835
1. Direct materials $2.45
Direct labor 2.10
Variable overhead 0.25
Fixed overhead ($180,000/200,000) 0.90
Total $5.70

Per-unit inventory cost on the balance sheet is $5.70.

Units in ending inventory = 11,300 + 200,000 208,000
= 3,300

Total ending inventory = $5.70 3,300 = $18,810

2. Absorption-costing income:
Sales (208,000 $9) ................................................................... $1,872,000
Less: Cost of goods sold (208,000 $5.70)............................. 1,185,600
Gross margin ........................................................................ $ 686,400
Less: Selling and administrative expenses ............................. 118,400
Operating income ................................................................. $ 568,000

3. Direct materials $2.45
Direct labor 2.10
Variable overhead 0.25
Total $4.80

Per-unit inventory cost under variable costing equals $4.80.
This differs from the per-unit inventory cost in Requirement 1 because the
balance sheet is for external use and reflects absorption costing. Variable
costing does not include per-unit fixed overhead.

4. Variable-costing income:
Sales ........................................................................................... $1,872,000
Less variable expenses:
Variable cost of goods sold (208,000 $4.80) ................... (998,400)
Variable selling and administrative .................................... (62,400)
Contribution margin .................................................................. $ 811,200
Less fixed expenses:
Fixed overhead ..................................................................... (180,000)
Fixed selling and administrative ......................................... (56,000)
Operating income ...................................................................... $ 575,200

8-16
Problem 835 (Concluded)
5. Absorption-costing income:
Sales (196,700 $9) ................................................................... $1,770,300
Less: Cost of goods sold (196,700 $5.70)............................. 1,121,190
Gross margin ........................................................................ $ 649,110
Less: Selling and administrative expenses ............................. 115,010
Operating income ................................................................. $ 534,100

Variable-costing income:
Sales ........................................................................................... $1,770,300
Less variable expenses:
Variable cost of goods sold ................................................ (944,160)
Variable selling and administrative .................................... (59,010)
Contribution margin .................................................................. $ 767,130
Less fixed expenses:
Fixed overhead ..................................................................... (180,000)
Fixed selling and administrative ......................................... (56,000)
Operating income ...................................................................... $ 531,130
Problem 836
1. Unit cost =
53,500
$160,500
= $3
Absorption-costing ending inventory = 1,500 $3 = $4,500

2. Variable-costing ending inventory:
$3 per unit $0.50 per unit = $2.50 per unit
Ending inventory = 1,500 $2.50 = $3,750

Sales ........................................................................................... $ 454,750
Less: Variable cost of goods sold ($2.50 53,500) ................ 133,750
Contribution margin ............................................................. $ 321,000
Less fixed expenses:
Fixed overhead ..................................................................... (27,500)
Fixed selling and administrative ......................................... (120,000)
Net income ................................................................................. $ 173,500

8-17
Problem 836 (Concluded)
3. Sugarsmooth, Inc.
Variable-Costing Income Statement
For the Coming Year

Drugstores & Discount Beauty
Supermarkets Stores Shops Total

Sales $ 454,750 $ 135,000 $ 90,000 $ 679,750
Less variable costs:
Cost of goods sold (133,750) (50,000) (25,000) (208,750)
Commissions (9,000) (9,000)
Return penalties (1,350) (1,350)
Packing expense (5,000) (5,000)
Contribution margin $ 321,000 $ 83,650 $ 51,000 $ 455,650
Less fixed expenses:
Shipping (45,000) (45,000)
Additional clerk (30,000) (30,000)
Segment margin $ 321,000 $ 8,650 $ 51,000 $ 380,650
Less common costs:
Overhead (27,500)
Selling and administrative (120,000)
Net income $ 233,150

4. Yes, all three customer groups are profitable. However, the discount stores
are the least profitable, and Sugarsmooth might consider how carefully it has
estimated the expenses associated with this customer group. Since Sugar-
smooth does not currently sell to discount stores, it may not want to expand
its customer base by selling to this segment.
Problem 837
1. Walker Company
Segmented Income Statement

Blenders Coffee Makers Total
Sales $2,200,000 $1,125,000 $3,325,000
Less: Variable cost of goods sold 2,000,000 1,075,000 3,075,000
Contribution margin $ 200,000 $ 50,000 $ 250,000
Less: Direct fixed expenses 90,000 45,000 135,000
Segment margin $ 110,000 $ 5,000 $ 115,000
Less: Common fixed expenses 115,000
Operating income $ 0

8-18
2. If the coffee maker line is dropped, profits will decrease by $5,000, the
segment margin. If the blender line is dropped, profits will decrease by
$110,000.
8-19
Problem 837 (Concluded)
3. Blenders Coffee Makers Total

Sales $2,405,000 $1,125,000 $3,530,000
Less: Variable cost of goods sold 2,200,000 1,075,000 3,275,000
Contribution margin $ 205,000 $ 50,000 $ 255,000
Less: Direct fixed expenses 90,000 45,000 135,000
Product margin $ 115,000 $ 5,000 $ 120,000
Less: Common fixed expenses 115,000
Operating income $ 5,000

Profits increase by $5,000.
Problem 838
1. Absorption costing:
Direct materials $1.20
Direct labor 0.75
Variable overhead 0.65
Fixed overhead 3.10
Unit cost $5.70

Cost of ending inventory = $5.70 200 = $1,140

2. Variable costing:
Direct materials $1.20
Direct labor 0.75
Variable overhead 0.65
Unit cost $2.60

Cost of ending inventory = $2.60 200 = $520

3. Selling price $ 7.50
Less:
Variable cost of goods sold (2.60)
Commission (0.75)
Contribution margin per unit $ 4.15

8-20
Problem 838 (Concluded)
4. Sales ($7.50 17,600) $132,000
Less:
Variable cost of goods sold $45,760
Commissions 13,200 58,960
Contribution margin $73,040
Less fixed expenses:
Fixed overhead $27,900
Fixed administrative 23,000 50,900
Operating income $ 22,140

Variable costing should be used, since the fixed costs will not increase as
production and sales increase.
Problem 839
1. Scented Musical Regular Total
Sales $13,000 $ 19,500 $25,000 $57,500
Less: Variable expenses 9,100 15,600 12,500 37,200
Contribution margin $ 3,900 $ 3,900 $12,500 $20,300
Less: Direct fixed expenses 4,250 5,750 3,000 13,000
Product margin $ (350) $ (1,850) $ 9,500 $ 7,300
Less: Common fixed expenses 7,500
Operating income (loss) $ (200)

Kathy should accept this proposal. The 30 percent sales increase, coupled
with the increased advertising, reduces the loss from $1,000 to $200. Both
scented and musical product-line profits increase. However, more must be
done. If the scented and musical product margins remain negative, the two
products may need to be dropped.

2. Regular
Sales $20,000
Less: Variable expenses 10,000
Contribution margin $10,000
Less: Fixed expenses 10,500
Operating income (loss) $ (500)

While dropping the two lines results in a $500 loss versus the original $1,000
loss, it is worse than the alternative offered in requirement 1. Other options
need to be developed.
8-21
Problem 839 (Concluded)
3. Combinations would be beneficial. Dropping the musical line (which shows
the greatest segment loss) and keeping the scented line while increasing
advertising yields a profit (the optimal combination).
Scented Regular Total

Sales $13,000 $22,500 $35,500
Less: Variable expenses 9,100 11,250 20,350
Contribution margin $ 3,900 $11,250 $15,150
Less: Direct fixed expenses 4,250 3,000 7,250
Product margin $ (350) $ 8,250 $ 7,900
Less: Common fixed expenses 7,500
Operating income $ 400
Problem 840
1. Ordering cost = 12 orders $125 = $1,500

2. Carrying cost = $6 (2,000/2) = $6,000

3. Total cost of current inventory policy = $1,500 + $6,000 = $7,500

4. EOQ =
2 24,000 $125
$6

= 1,000

5. Ordering cost at EOQ =
1,000
24,000
$125 = $3,000
Carrying cost at EOQ = $6
2
1,000
= $3,000

6. Total cost EOQ policy = $3,000 + $3,000 = $6,000

Savings = $7,500 $6,000 = $1,500

7. Cost of ordering 2,000 units = Ordering cost + Carrying cost
= $1,500 + $6,000
= $7,500

Cost of ordering 1,000 units = Increased price + Ordering cost + Carrying cost
= ($0.05 24,000) + $3,000 + $3,000
= $1,200 + $3,000 + $3,000
= $7,200

Even with the price increase, it is better to order the economic order quantity.
8-22
Problem 841
1. Ordering cost = $40
400
14,000

= $1,400

Carrying cost = $1.75*
2
400

= $350

*10% of purchase price or 0.10 $17.50.

Total cost = $1,400 + $350 = $1,750

2. EOQ =
2 14,000 $40
$1.75


= 000 , 640

= 800

Ordering cost = $40
800
14,000

= $700

Carrying cost = $1.75
2
800

= $700

Total cost = $700 + $700 = $1,400

Savings = $1,750 $1,400 = $350

3. Rate of usage = 7 50 = 350 days
=
350
14,000
= 40 blocks per day

Reorder point = Average rate of usage Lead time
= 40 5
= 200

This coincides with the current reorder policy.

8-23
Problem 841 (Concluded)
4. The order quantity would have to be 600 instead of 800 (the EOQ). If so, the
following inventory costs would be incurred:
Ordering cost = $40
600
14,000

= $933

Carrying cost = $1.75
2
600

= $525

Total cost = $933 + $525
= $1,458

This restriction would mean an additional cost of only $58 ($1,458 $1,400)
over the cost of using the EOQ.

5. The most cheese that should be kept on hand given the 10-day constraint is
400 blocks (40 10). Reorder would occur when inventory dropped to 200
units.

8-24
CASES
Case 842
1. Many legitimate reasons support the creation of inventory (e.g., the need to
avoid stockouts and the need to ensure on-time delivery). Paul Chessers
reasons, however, are based on self-interest and ignore whats best for the
company. Knowingly producing for inventory to obtain personal financial
gain at the expense of the company certainly could be labeled as unethical
behavior.

2. Since the decision to produce for inventory was not motivated by any sound
economic reasoning, and Ruth knows the real motive behind the decision,
she should feel discomfort in the role she has been asked to assume. If she
decides to appeal to higher-level management, the divisional manager can
counter with arguments that inventory was created because he expected the
economy to turn around and did not want to be in a position of not having
enough goods to meet demand. Even though Ruth may have a difficult time
proving any allegation of improper conduct, if she is convinced that the
behavior is truly unethical, then appeals to higher-level management with the
prospect of ultimate resignation should be the route she takes.

Alternatively, Ruth might decide that the use of absorption costing for
internal reporting and bonus calculation has led to this situation. She could
lobby higher management to begin using variable costing as a way of
avoiding these dysfunctional decisions. Ruth will have a very hard time
proving unethical behaviorat worst, Paul may be accused of having poor
judgment regarding future economic upturns.

3. The following standards may apply:
Integrity. Refrain from engaging in any conduct that would prejudice carrying
out duties ethically. (III-2)
Credibility. Communicate information fairly and objectively. (IV-1) Disclose
fully all relevant information that could reasonably be expected to influence an
intended users understanding of the reports, analyses, or recommendations.
(IV-2)
8-25
Case 843
1. By discussing the amount by which his company and Piura have reduced
costs, Mac may have violated the confidentiality standard. Specifically, Mac
should: keep information confidential except when disclosure is authorized
or legally required. He may also be involved in a conflict of interest, although
he may not have realized this until the conversation of the evening unfolded.
Finally, he may be guilty of using confidential information for unethical or
illegal advantage.

2. Mac would violate a host of standards: disclosing confidential information,
accepting a gift or favor that would influence his actions, actively subverting
his companys legitimate objectives, and engaging in an activity that would
discredit the profession. He would be well advised to refuse the offer and
avoid any disclosure of information.