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?