Inventory and Capacity Analysis

Steve Smith has completed an evaluation
of the effects of a favorable production volume variance from the prior
period. He proposes to Roberta Blake that the use of a variable costing
income statement rather than an absorption costing income statement for
the basis calculating incentive rewards would encourage more ethical
behavior, when rewards are based on operating income.

• Do you agree with Smith’s suggestion?
• Are there any reporting considerations which impact the preparation of a variable costing income statement?
• If
  Blake and Smith agree that only absorption costing is appropriate, are
  there any methods to fairly capture the effect of increased inventories
  during times of overproduction?