Kersten Company makes and sells a toy plane. Kersten incurred the following cost
ID: 2415791 • Letter: K
Question
Kersten Company makes and sells a toy plane. Kersten incurred the following cost in its most recent year:
Cost Items Report on Income Statement
Shipping and handling cost ($0.75 per unit)
Cost of renting the administration building
Utility cost for the for the manufacturer plant (0.25 per unit produced)
Manufacturing plant manager’s salary
Materials cost ($4 per unit produced)
Real estate taxes on the manufacturing equipment
Packaging cost ($1 per unit produced)
Wages of the plant security guard
Cost of TV commercials
Labor cost ($3 per unit)
Sales commission (1% of sales)
Sales manager’s salary
Kersten could purchase the toy planes from a supplier. If it did, the company would continue to sell them using its own logo, advertising program, and sales staff.
Identify each cost as relevant or irrelevant to the outsourcing decision and indicate whether the cost is fixed or variable relative to the number of toy planes manufactured and sold.
Explanation / Answer
Cost relevance analysis of Kersten Company
Student Tip
Cost relevance analysis of Kersten Company
Cost Items Report on Income Statement Type of Cost Reason Nature of Cost Shipping and handling cost ($0.75 per unit) Irrelevant Shipping and handling cost is incurred at the time of sale( eg. the shipping charge that you pay at Amazon or ebay) and would continue to be incurred even if manufacturing is outsourced. Variable Cost of renting the administration building Irrelevant Cost of Renting the admin building has no relation with manufacturing activity and would continue to be incurred even if manufacturing is outsourced. Fixed Utility cost for the for the manufacturer plant(0.25 per unit produced) relevant Utility cost is directly attributable to the manufacturing and hence would not have to be incurred, once the manufacturing is outsourced. Variable Manufacturing plant manager’s salary relevant Manufacturing plant manager's salary would not have to be paid if production is not done in-house and hence would not have to be incurred, once the manufacturing is outsourced. Fixed Materials cost ($4 per unit produced) relevant Material cost would not be incurred since no manufacturing would be carried out in house and hence would not have to be incurred, once the manufacturing is outsourced. Variable Real estate taxes on the manufacturing equipment Irrelevant Real estate taxes are paid to Federal Authorities irrespective of the no of units produced. Therefore even is the manufacturing is outsourced, taxes will have to be paid, since the equipments, though not in use, but are in place. Fixed Packaging cost ($1 per unit produced) relevant Packing cost is taken as relevant on an assumption that the outsourced party would also pack the product. Therefore , once the manufacturing activity is outsourced, this cost will also do away. If packing is to be done by Kersten , then this cost will be relevant. Variable Wages of the plant security guard Irrelevant Wages of Plant security guard would have to be paid even if production is not done in-house, since the equipments needs to be protected from possible theft or trespassing and hence would have to be incurred, even if the manufacturing is outsourced. Fixed Cost of TV commercials Irrelevant Cost of TV commercials is for promoting the brand and product and would have to be paid even if production is not done in-house, since the advertisement and promotion is not being outsourced and hence would have to be incurred, even if the manufacturing is outsourced. Fixed Labor cost ($3 per unit) relevant Labor cost , just like, Material cost would not be incurred since no manufacturing would be carried out in house and hence would not have to be incurred, once the manufacturing is outsourced. Variable Sales commission (1% of sales) Irrelevant Sales commission paid as a percentage of sales has no nexus with the manufacturing activity and would have to be paid even if production is not done in-house. Variable Sales manager’s salary Irrelevant Also the sales manager's salary would have to be paid as it has not relation with the manufacturing activity that is proposed to be outsourced. Fixed
Student Tip
A cost which is relevant for an industry but might be irrelevant for another. Hence a thorough understanding of the nature of expense is necessary. Also a sunk cost like depreciation, is always an irrelevant cost. Unless the business also plans to sell off the plant equipment, along with outsourcing the plant activity. Unless and until such sell of is mentioned we always assume that all equipment remains intact, only the activity inside the plant will be stopped, on outsourcing.Related Questions
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