Managing Earnings, Denominator Capacity-Level, and Ethics Any given cost-information sys- tem is a function of a number of design choices. For product-costing purposes, one such design choice relates to how overhead, particularly fixed manufacturing overhead, application rates are determined. As controller for your company, you have been asked to prepare a written presentation for an upcoming meeting of the board of directors of your company. In preparing this assignment, assume that board members are reasonably knowledgeable about financial-reporting issues, but not necessarily about the intricacies of cost accounting systems. As you construct your document, feel free to consult outside references in addition to the material in your text. You can assume that this document is meant as a formal presentation to members of the board. Thus, your writing should be concise, clear, and reflective of proper grammar and construction.
Required: Prepare, in proper form, a memo for the board that addresses the following issues:
1. Explain how manufacturing overhead rates are constructed in conventional cost accounting systems. Speak separately about fixed versus variable overhead application rates. What key choices must be made in establishing these rates? In answering this question, you might want to discuss differences (if any) between current IRS (income tax) requirements and internal reporting purposes, and between financial reporting requirements (e.g., FASB ASC 330-10-30, previously SFAS No. 151-available at www.asc.fasb.org) and internal reporting purposes.
2. Your company uses a standard cost system. As such, at the end of each period it must "clean up" the accounts by disposing of any standard cost variances that occurred for the period. You need to edu- cate members of the board about how the variances for fixed manufacturing overhead are disposed of at the end of the period.
In your answer, pay particular attention to the following two financial- reporting issues: (a) the requirements of FASB ASC 330-10-30, and (b) how, under absorption costing, reported earnings can be "managed" by choice of the denominator volume used to establish the fixed overhead application rate.
3. Access Institute of Management Accountant's Statement of Ethical Professional Practice (www.imanet.org/about_ethics_statement.asp). Which of the stated standards relate directly to the issue of setting (fixed) overhead application rates and the decision as to how any resulting production-volume variances are disposed of for financial-reporting purposes? Be specific.