The Implications of Absorption Cost Accounting and Production Decisions for Future Firm Performance and Valuation

46 Pages Posted: 2 Oct 2005 Last revised: 8 Sep 2010

See all articles by Mahendra Gupta

Mahendra Gupta

Washington University, St. Louis

Chandra Seethamraju

Franklin Templeton Investments

Mikhail Pevzner

University of Baltimore - Merrick School of Business

Date Written: February 3, 2010

Abstract

We examine how inventory overproduction among high fixed costs firms affects these firms’ contemporaneous and future accounting performance, and how financial analysts and the stock market incorporate implications of these relations in their reactions. We find that higher fixed costs firms engaging in opportunistic overproduction are able to increase their contemporaneous return on assets (ROAs), but only those higher fixed costs firms that also experience inventory increases, sales declines, and issue common stock also experience declines in their future accounting performance. We further find that financial analysts are aware of this phenomenon and appropriately reduce their forecasts of future earnings per share (EPS) for higher fixed costs firms that experience sales declines and inventory increases. In general, we do not find that the stock market penalizes such opportunistic overproduction.

Keywords: Inventory, Overproduction, Analyst Forecasts, Real Earnings Management

JEL Classification: M40, M41

Suggested Citation

Gupta, Mahendra R. and Seethamraju, Chandrakanth and Pevzner, Mikhail, The Implications of Absorption Cost Accounting and Production Decisions for Future Firm Performance and Valuation (February 3, 2010). Contemporary Accounting Research, 27(3), Fall 2010, Available at SSRN: https://ssrn.com/abstract=817510

Mahendra R. Gupta (Contact Author)

Washington University, St. Louis ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-4565 (Phone)
314-935-6359 (Fax)

Chandrakanth Seethamraju

Franklin Templeton Investments ( email )

Multi Asset Strategies
P.O. Box 997152
San Mateo, CA 95899-7152
United States

Mikhail Pevzner

University of Baltimore - Merrick School of Business ( email )

1420 N. Charles St.
Baltimore, MD 21201-5779
United States

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