7.7 Examples of dysfunctional decisions managers may make to increase reported operating profit are a Plant managers may switch production to those orders that absorb the highest amount of manufacturing overhead, irrespective of the demand by customers. b Plant managers may accept a particular order to increase production even though another plant in the same company is better suited to handle that order. c Plant managers may defer maintenance beyond the current period to free more time for production. 7.8 Approaches used to reduce the negative aspects associated with using absorption costing include a Changing the accounting system. • Adopting either variable or throughput costing, both of which reduce the incentives of managers to buildup stock. • Adopting a stock-holding charge for managers who tie up funds in stock. b Extending the time period used to evaluate performance. By evaluating performance over a longer time period (say, three to five years, the incentive to take short-run actions that reduce long-term profit is lessened. c Including non-financial as well as financial variables in the measures used to evaluate performance. 7.9 The theoretical capacity and practical capacity denominator-level concepts emphasise what a plant can supply. The normal utilisation and master-budget utilisation concepts emphasise what customers demand for products produced by a plant. 7.10 Normal utilisation is the denominator-level concept based on the level of capacity utilisation that satisfies average customer demand over a period (say, two or three years, which includes seasonal, cyclical or other trend factors. Where managers do not have a high level of confidence in forecasting two to three years in the future, they may prefer master-budget utilisation (which is based on only one year ahead) as the denominator level.
