In a production environment, there is absorption costing and marginal costing also known as variable costing which is used to allocate costs to a unit or to a production process. Both are used according to the size of the business and accounting policies in the same. In the given case, using absorption costing led to a production overrun so that all the employees earn yearend bonus. This led the company to incur unnecessary costs and increased the overhead costs of production.
In variable costing, you include all the variable expenses such as shipping, supplies, fuel and administrative costs which vary with the change in production quantity. The full cost of fixed overheads is added for that particular period, these include rent, salary, electricity and purchase of raw materials. Variable costing changes with the change in production quantity hence it provides a detailed and a clear figure for the cost of one unit of production.
The situation here would have changed had the company used variable costing as a means to calculate additional compensation. In that case, the production overrun would not have taken place and the employees would have been compensated on a per unit of production basis. Variable costing for employees involves compensating them for each unit of production, usually variable costing for employees involves bonus and overtime paid for additional working hours or for additional production. Variable costing also ensures that the inventories are not running over the requirement and the production remains at par with the inventory and the forecasted sales. The variable expenses and fixed expenses are deducted from the revenue to show the profit. The impact of fixed assets is also reduced if variable costing is applied. Hence, in the given case, it would be advisable for the company to use variable costing as a means to determine the compensation of its employees instead of using absorption costing for the same.
References
Agarwal, R. (n.d.). Advantages and Limitations of Variable Costing. Retrieved from Your article library: http://www.yourarticlelibrary.com/accounting/costing/advantages-and-limitations-of-variable-costing/52647/
Johnston, K. (n.d.). Advantages & Disadvantages of Using Absorption Vs. Variable Costing. Retrieved from Houston Chronicle: http://smallbusiness.chron.com/advantages-disadvantages-using-absorption-vs-variable-costing-34282.html
