Question

Create a response to the below discussion post:

Reading the Toxaway Case Study we understand that the company ultimately needs to make decisions and calculate the break-even points. An intern was asked to prepare a segmented income statement to assist the company. The intern instead prepared the absorption format segmented income statement. Absorption cost statements puts both variable and fixed overhead into the unit product cost instead and is not necessarily the best method to find the break-even point. With the decision to allocate the common fixed expense to the Commercial and Residential segment will cause issues, and the intern will need to find another way to charge off the accounts. The intern trying to allocate the expenses it will casuse the margin to be obscured and the company may look to see why there is no profit reported to the net income statement. This does not give managers a clear picture of what direct information is to be used to calculate the break-even without fluctuations. The managers need the “cost that will be incurred to make one more unit” (Garrison, Noreen, & Brewer, 2018). Absorption cost can be used but in my opinion, it does not give the information needed to make an informed decision.

Answer 1

Absorption costing although distinguishes between variable and fixed costs it does not do it in totality i.e. while putting up the income statement there is no differentiation. To cover this deficiency, the costing method that will be most appropriate to use where is a difference in variable and fixed costs is variable costing or marginal costing. In this method, the contribution approach is used wherein the total variable costs are deducted from revenues to arrive at contribution. Break even point here becomes clear as it is fixed cost by contribution ratio. In a sense it tells the contribution needed to cover the fixed costs.