Impact of Just In Time (JIT) Inventory Methods on Variable and
Absorption Costing System:
Learning Objectives:
- Why net operating income figure under
variable costing and absorption costing systems are almost same when
companies use just in time manufacturing and inventory control system?
Variable
costing and
absorption costing produce
different
net operating income figures whenever the number of units produced
is different from the number of units sold. In other words, whenever there
is a change in the number of units in inventory.
Absorption
costing net
operating income figure can be erratic, sometimes moving in a direction that
is opposite from the movement in sales.
When companies use
just in time (JIT) methods,
these problems are reduced. The erratic movement of net operating income
under
absorption costing and the difference in net operating income between
absorption and
variable
costing occur because of changes in the number of
units in inventory. Under
just in time (JIT) goods are produced to
customers' orders and the goal is to eliminate finished goods inventory
entirely and reduce work in process inventory to almost nothing. If there is
very little inventory, the changes in inventories will be very small and
both
variable
costing and
absorption costing will show basically the same
net operating income figure. In that case,
absorption costing
net operating income will move in the same direction as movement in sales.
Of course the cost of a unit of product will
still be different between variable and absorption costing. But when
just in time (JIT) is used, the differences in
net operating income will largely
disappear.
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