Tough times can bring out the worst in people. When companies are desperate to stay in business or to report more favourable earnings to the market, some managers just can’t seem to resist the temptation to manipulate reported profits. Unfortunately, inventory is sometimes a tempting target of such manipulation. While some companies may boost their own inventories to report higher profits, other companies use inventory manipulation in a more round- about way: they produce excess inventory but then find ways to induce their customers to buy more product than they really need (known as “channel stuffing” or “trade loading”).
Required:
Using the concepts discussed in this chapter, consider how the requirement to report for financial accounting purposes under absorption costing might play a role. Could a firm with sales below the break-even point still report profits?