ESSAY TOPIC 1:

There are two methods given mainly mentioned one of which is currently being followed by the
treasurer which is allocating the whole cost to Work in Progress inventory, Finished Goods Inventory
and Cost of goods sold Account. The other method which was suggested by the assistant was to assign
the entire amount of overhead into Cost of Goods Sold account. Now to choose one of the method, we
have to look at the pros and cos of both of the topics and then give conclusion based on which method
fits the best according to the aims of the corporation.

The method currently being followed by the treasurer is also called “Proration method” in which the
under applied overhead is allocated into inventories of WIP and FGs, and COGS account according to
their ratios. The major pro of this method is that it considers each and every cost and allocate it
accordingly. But the con of this method is that it doesn’t account for seasonal or one time large
expenses, therefore it may lead to higher inventory and lower cost of goods sold. Due to this it can
impact financial statements, therefore effecting costs and eventually tax consequences. Secondly this
method increases the cost of goods sold only by a small proportion rather than the whole amount of
amount of under applied overheads which can lead to lower cost than actual costs and later on higher
tax consequences.

The second which was advised the assistant was allocating whole under applied overheads into cost of
goods sold, which is also called as “Direct Write-Off Method”. Allocating whole amount of under applied
overheads will lead to higher cost of goods sold and eventually leading to lower tax charges. Another
benefit of this method is that it is a lot simpler to calculate and it shows direct impact of the overheads
on the income statement. And since there isn’t any calculation required it is a lot easier to understand it.
About the cons of this method, this method doesn’t show true depiction of the costs as typically cost of
goods sold is a smaller percentage of the overheads. And it doesn’t depicts the true value of inventory
left in the business. Secondly as it directly allocates the COGS, it shows higher costs leading to lower
profits, as the sales and other incomes are constant. This method negatively impacts the company’s
profits and later on negatively impacts negatively on the ratios as well. This method also doesn’t account
for actual individual job order costing, and can provide inaccurate individual product costs due to all the
overheads absorbed by other jobs.

Although the methods two leads in smaller amount of tax charges but it also leads to lower profits which
might have a negative impact on the company’s financial statement and ratios. It will lead to lower a
negative impact on company’s image. It also leads to inaccurate depiction of the cost of goods sold as
well as well as the inventories of the company as it will lead to lower inventory later on. Method two
shows short term benefit only as costs adjusted to costs of goods sold lead to smaller amount of
inventory which would be a lot more if the first method was followed which shows a better depiction of
each account. It will lead to lower amount of inventory which will shower inaccurate lower profits in the
later period leading to higher taxes, which means that the tax that we try to save this period will be
charged to us in the later period.
Secondly if we follow the second method, the sudden increase in cost of goods sold will look
questionable to the auditor, as this method is not transparent. If the under applied overheads are
allocated as per proration method, it will show the actual positions more accurately than the method
two which makes it less questionable. Lastly in the second method, allocation of under applied
overheads to cost of goods sold will lead to much lower profit than the actual profits which in turn will
show that the corporation is in a weaker position which will be unattractive for the investors and
shareholders. It will also significantly affect the ratios of the company in a negative manner leading to a
weaker position in front of lenders and shareholders.

Therefore as the treasurer of ABI, Inc., its better to stick to the older method as it is more profitable in
the long run. The direct write off method suggested by the assistant indeed will result into a tax
reduction but this method is questionable and the tax saved this year will be charged to us in the later
period eventually. Secondly this method will affect the ability to attract the investors and lender due to
weaken financial position. Although following the proration method leads to higher tax liability but it
doesn’t only promises a much better and accurate depiction of the financial statements but it is more
profitable foe the corporation in terms on net profit as well as while attracting investors.