Absorption costing of inventories,as required by US GAAP,has been criticized for encouraging managers to increase year-end inventories in order to boost reported profits.Which of the following techniques is the most effective at resolving this problem?

A) Senior management control of inventory levels
B) Adoption of just-in-time (JIT) production system
C) Reward managers based upon the residual income approach
D) Use variable costing to determine income for bonus purposes
E) None of the choices are correct

Question

Nakisa Ghavami · Accepted Answer

Final Answer : B, Explanation :  Adopting a just-in-time production system reduces the need for large end-of-year inventories as materials and goods are obtained shortly before production is required. This reduces the incentives for managers to increase inventories and boost profits. Senior management control of inventory levels may be effective, but it may not address the root cause of the problem. Rewarding managers based on residual income may encourage managers to make decisions that maximize profits, including increasing year-end inventories. Using variable costing for bonus purposes may also encourage managers to make decisions that maximize profits, rather than making decisions in the long-term interest of the company. Therefore, adopting a just-in-time production system is the most effective solution.

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