Yes the accountant’s suggestion makes sense. What the accountant suggests is that with the increase in the production the cost of goods sold will decrease as fixed manufacturing cost will be same for whatever amount you produce. Let us take an example.
For example a company’s fixed manufacturing cost is Rs. 500,000. So whether you produce 100,000 unit or 200,000 units the fixed cost will still remain as Rs. 500,000. But with 100,000 unit the cost of goods sold will be Rs. 5 per unit (Rs. 500,000 divided by 100,000 units) while the cost of goods sold for 200,000 units will be only Rs. 2.5 per unit.
So let us assume that your sales will remain at 100,000 units and you sale it for Rs. 10 per unit. Then in the first case you will sale 100,000 units (total production) at Rs. 10 earning Rs. 10,00,000. Similarly in the second case, out of 200,000 units produced you will sale 100,000 units for Rs. 10 and earn the same amount of Rs. 10,00,000 but the cost of production will only be 250,000 earning you a profit of Rs. 750,000 where as in the first case with production cost of Rs. 5 you will only be earning Rs. 500,000. In addition, in the second case with production of 200,000 units you will also have an inventory shown in the balance sheet for 100,000 units at Rs. 2.5 equalling to Rs. 250,000.
"As innovation and mechanization continue in manufacturing operations, fixed costs become a larger proportion of product costs. Higher fixed manufacturing costs can produce larger differences between absorption costing and direct costing net incomes. (Baxendale & Foster, 2010)” However absorption costing is considered to have two major weaknesses. One it allows the chances for manipulation of the net income with the scale of production. It also does not clarify on the amount of variable and fixed cost. (Sopariwala, 2009)
References
Baxendale, S., & Foster, B. (2010, Sept/Oct). ABC ABSORPTION AND DIRECT COSTING INCOME STATEMENTS. Cost Management; Boston , pp. 5-14.
Sopariwala, P. R. (2009, Nov/Dec). THE ABSORPTION VS. DIRECT COSTING DEBATE: A COMPROMISE SOLUTION. Cost Management; Boston , pp. 41-46.
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Yes the accountant’s suggestion makes sense. What the accountant suggests is that with the increase in the production the cost of goods sold will decrease as fixed manufacturing cost will be same for whatever amount you produce. Let us take an example.
For example a company’s fixed manufacturing cost is Rs. 500,000. So whether you produce 100,000 unit or 200,000 units the fixed cost will still remain as Rs. 500,000. But with 100,000 unit the cost of goods sold will be Rs. 5 per unit (Rs. 500,000 divided by 100,000 units) while the cost of goods sold for 200,000 units will be only Rs. 2.5 per unit.
So let us assume that your sales will remain at 100,000 units and you sale it for Rs. 10 per unit. Then in the first case you will sale 100,000 units (total production) at Rs. 10 earning Rs. 10,00,000. Similarly in the second case, out of 200,000 units produced you will sale 100,000 units for Rs. 10 and earn the same amount of Rs. 10,00,000 but the cost of production will only be 250,000 earning you a profit of Rs. 750,000 where as in the first case with production cost of Rs. 5 you will only be earning Rs. 500,000. In addition, in the second case with production of 200,000 units you will also have an inventory shown in the balance sheet for 100,000 units at Rs. 2.5 equalling to Rs. 250,000.
"As innovation and mechanization continue in manufacturing operations, fixed costs become a larger proportion of product costs. Higher fixed manufacturing costs can produce larger differences between absorption costing and direct costing net incomes. (Baxendale & Foster, 2010)” However absorption costing is considered to have two major weaknesses. One it allows the chances for manipulation of the net income with the scale of production. It also does not clarify on the amount of variable and fixed cost. (Sopariwala, 2009)
References
Baxendale, S., & Foster, B. (2010, Sept/Oct). ABC ABSORPTION AND DIRECT COSTING INCOME STATEMENTS. Cost Management; Boston , pp. 5-14.
Sopariwala, P. R. (2009, Nov/Dec). THE ABSORPTION VS. DIRECT COSTING DEBATE: A COMPROMISE SOLUTION. Cost Management; Boston , pp. 41-46.