| Course | ACC-7000 Managerial Accounting for Decision Making |
|---|---|
| Module | Module 3 |
| Paper type | Module 3 written assignment: absorption costing processes and issues |
| Length | About 739 words, 5 pages |
| Format | APA 7 student paper |
| School | Thomas Edison State University |
| Program | MBA in Accounting |
| Updated | October 2026 |
Free sample paper for ACC 7000 Module 3
A Profit From Inventory: Absorption Costing, Overproduction and Overhead Rates at a Clifton Cabinet Maker
Student Name
MBA in Accounting, Thomas Edison State University
ACC-7000: Managerial Accounting for Decision Making
Mentor Name
Month Day, Year
A Profit From Inventory: Absorption Costing, Overproduction and Overhead Rates at a Clifton Cabinet Maker
Introduction
Absorption costing assigns all manufacturing costs, variable and fixed, to units produced. Variable costing assigns only variable manufacturing costs to units and expenses fixed overhead in the period it is incurred. Generally accepted accounting principles and the tax law require absorption costing for external reports, but the two methods report different income whenever production and sales differ, because absorption costing carries some fixed overhead into inventory (Zimmerman, 2014).
Part A: Two Income Statements
Passaic Valley sells cabinets at $400. Variable manufacturing cost is $180 a unit, variable selling cost $20 a unit, fixed manufacturing overhead $1,440,000 and fixed selling and administrative cost $600,000. With 12,000 units produced, fixed overhead is $120 a unit under absorption costing.
The $360,000 difference equals the 3,000 units in ending inventory times $120 of fixed overhead each. Under absorption costing, that overhead sits on the balance sheet until the cabinets are sold; under variable costing, it is an expense now. If the plant had built only the 9,000 units it sold, fixed overhead would have been $160 a unit, all of it expensed, and absorption income would also have been a $240,000 loss.
| Year 1 | Absorption costing | Variable costing |
|---|---|---|
| Sales, 9,000 units | $3,600,000 | $3,600,000 |
| Cost of goods sold | (2,700,000) at $300 | (1,620,000) at $180 |
| Variable selling | (180,000) | (180,000) |
| Fixed manufacturing overhead expensed | Included in cost of goods sold | (1,440,000) |
| Fixed selling and administrative | (600,000) | (600,000) |
| Operating income | $120,000 | ($240,000) |
Part B: The Incentive to Overproduce
The plant manager's bonus is based on absorption costing operating income. Producing 3,000 cabinets the company could not sell turned a $240,000 loss into a $120,000 profit without a single additional sale. The company paid for the materials, labor, storage and risk of obsolescence of those cabinets. Roychowdhury (2006) found evidence that firms overproduce to lower reported cost of goods sold and avoid reporting losses, which shows that this incentive operates in practice and not only in textbook problems.
Zimmerman's remedies follow from organizational architecture. The company can evaluate the plant manager on variable costing income, which removes the incentive; add a charge for inventory held, so building inventory carries a cost; or base the bonus on sales, inventory turnover and quality as well as profit. Absorption costing remains necessary for external reporting, but internal performance measures need not use it.
The cost of the inventory build is real. Holding 3,000 extra cabinets ties up $540,000 of variable cost in working capital, at the company's cost of capital, and adds storage, insurance and the risk that styles change before the cabinets sell. If even a tenth must be discounted by 30 percent, the company loses $36,000 of margin to create a paper profit.
Part C: Overhead Rates and the Death Spiral
Passaic Valley applies overhead at a single plant-wide rate per direct labor hour. It makes two lines: standard cabinets in long runs and custom cabinets in small batches with many design changes. Custom work uses 20 percent of labor hours but drives most setups, engineering changes and purchase orders.
The labor-hour rate assigns custom work 20 percent of overhead, $288,000. The activity drivers assign it $879,000: $336,000 of setups, $288,000 of engineering, $180,000 of purchasing and $75,000 of facility cost. Standard cabinets are therefore overcosted and custom cabinets undercosted. Banker et al. (1995) found that manufacturing overhead rises with the number of transactions and the complexity of production, not only with volume, which is what these drivers capture.
The distortion can start a death spiral. Overcosted standard cabinets look unprofitable, so the company raises their price, loses volume to competitors and spreads the same fixed overhead over fewer units, raising their cost again. If it drops standard cabinets, the fixed overhead remains and lands on custom work. The cure is to price with costs that reflect the activities each product uses, and to remember that in the short run fixed overhead does not disappear when a product is dropped.
Activity-based costing has its own costs: identifying drivers, collecting data on setups and change orders and maintaining rates as products change. For a two-line plant, four pools are enough to correct the main distortion without building an elaborate system.
| Overhead pool | Cost | Driver | Custom share of driver |
|---|---|---|---|
| Machine setups | $480,000 | Setups | 70% |
| Engineering changes | $360,000 | Change orders | 80% |
| Purchasing and receiving | $300,000 | Purchase orders | 60% |
| Facility | $300,000 | Square feet | 25% |
| Total | $1,440,000 | | |
References
Banker, R. D., Potter, G., & Schroeder, R. G. (1995). An empirical analysis of manufacturing overhead cost drivers. Journal of Accounting and Economics, 19(1), 115-137. https://doi.org/10.1016/0165-4101(94)00372-C
Roychowdhury, S. (2006). Earnings management through real activities manipulation. Journal of Accounting and Economics, 42(3), 335-370. https://doi.org/10.1016/j.jacceco.2006.01.002
Zimmerman, J. L. (2014). Accounting for decision making and control (8th ed.). McGraw-Hill.
Reading the ACC 7000 Module 3 assignment instructions
In the third module, the problems ask how full costing changes reported profit and the behavior of the managers who report it. Expect problems that compute overhead rates and applied overhead, compare absorption and variable costing income, reconcile the difference through inventory, explain the overproduction incentive, compare plant-wide, departmental and activity-based rates and discuss the death spiral. Passaic Valley's numbers are invented for teaching. Expect overhead rate problems with a twist, such as a change in volume or a second product line, that tests whether you understand why costs shift. Some versions ask for the variable costing statement only.
How this ACC 7000 Module 3 example is built
The introduction defines both costing methods and why they differ. Part A prepares both income statements side by side, reconciles them through ending inventory and shows what income would have been without the inventory build. Part B explains the overproduction incentive with research evidence and offers remedies from organizational architecture. Part C compares a labor-hour rate with activity drivers in a table, computes the cost shift between product lines, cites evidence on overhead drivers and explains the death spiral and its cure. Each part ends with the decision or behavior it affects. The overhead table shows each pool, its driver and the custom line's share, so the cost shift can be traced pool by pool.
ACC 7000 Module 3 rubric: what earns full marks
Absorption costing problems earn up to 5 points under the course rubric. For this module, mentors check both income statements, the reconciliation of the difference, explanation of the incentive to overproduce and correct application of overhead rates and activity drivers. Zimmerman's emphasis on behavior means answers should explain how the costing system affects decisions, not only compute costs. Remedies tied to performance measures earn credit. A reconciliation of absorption and variable income through ending inventory, an activity-based allocation that shows the dollar shift between products and a remedy for the overproduction incentive are the three elements mentors check most closely. Showing the computations in tables earns partial credit. Mentors also credit answers that put a dollar cost on holding the extra inventory.
Common ACC 7000 Module 3 mistakes, and how to avoid them
Absorption costing answers lose points for misplacing fixed overhead, failing to reconcile the two incomes and missing the behavioral point. Reconcile the difference with ending inventory times fixed overhead per unit. Ask how each costing method would change what a manager does. When comparing overhead rates, show the cost shift in dollars. Remember that fixed overhead does not vanish when a product is dropped. State that explicitly in any death spiral discussion. Show the activity rate for each pool, then multiply by the product's use of each driver. Tie the two profit figures together first. A free first sample of your own ACC-7000 Module 3 problems is available on request.
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ACC 7000 Module 3 questions, answered
Where can I find a free ACC 7000 Module 3 sample paper?
The Clifton cabinet maker problem is worked above: absorption and variable costing income, the overproduction incentive, activity drivers and the death spiral.
Why does absorption costing income differ from variable costing income?
Absorption costing defers fixed overhead in inventory when production exceeds sales, so it reports higher income in that period.
How can overproduction increase reported profit?
Spreading fixed overhead over more units lowers cost per unit and moves overhead into ending inventory instead of expense.
What is the death spiral in cost allocation?
Raising prices on products burdened with allocated fixed costs, losing volume and spreading the same costs over fewer units.
Why use activity-based cost drivers?
Because overhead often varies with setups, changes and transactions rather than volume, so volume rates distort product costs.