Task 1: Cost behaviours and cost classifications
Steve Morgan, controller for Newton Industries, was reviewing production cost reports for the year. One amount in these reports continued to bother him-advertising. During the year, the company had instituted an expensive advertising campaign to sell some of its slower-moving products. It was still too early to tell whether the advertising campaign was successful.
There had been much internal debate as how to report advertising cost. The Vice President of Operations argued that advertising costs should be reported as a cost of production, just like direct materials and direct labour. He therefore recommended that this cost be identified as manufacturing overhead and reported as part of inventory costs until sold. Others disagreed.
Morgan believed that this cost should be reported as an expense of the current period, so as not to overstate net income. Others argued that it should be reported as prepaid advertising and reported as a current asset. The president finally had to decide the issue. He argued that these costs should be reported as inventory. His arguments were practical ones. He noted that the company was experiencing financial difficulty and expensing this amount in the current period might jeopardize a planned bond offering. Also, by reporting the advertising costs as inventory rather than as prepaid advertising, less attention would be directed to it by the financial community.
Required
Draft a response to Steve Morgan evaluating the arguments put forward in relation to how advertising cost should be accounted for in the financial statements. In your opinion, recommend what is the most appropriate way to account for such costs. Justify your answer.
Task 2: Understanding Overheads
Curtis Rich, the cost accountant for Hi-Power Mower Company. recently installed activity based costing at Hi-Power's St. Louis lawn tractor (riding mower) plant where three models-the 8-horsepower Bladerunner, the 12-horsepower Quickcut, and the 18-horsepower Supercut-are manufactured.
Curtis's new product costs for these three models show that the company's traditional costing system had been significantly under costing the 18-horsepower Supercut. This was due primarily to the lower sales volume of the Supercut compared to the Bladerunner and the Quickcut.
Before completing his analysis and reporting these results to management. Curtis is approached by his friend Ed Gray, who is the production manager for the 18-horsepower Supercut model. Ed has heard from one of Curtis's staff about the new product costs and is upset and worried for his job because the new costs show the Supercut to be losing. rather than making, money.
At first, Ed condemns the new cost system, whereupon Curtis explains the practice of activity based costing and why it is more accurate than the company's present system. Even more worried now, Ed begs Curtis, "Massage the figures just enough to save the line from being discontinued. You don't want me to lose my job, do you? Anyway. nobody will know." Curtis holds firm but agrees to recompute all his calculations for accuracy before submitting his costs to management.
Required
As you are Curtis's assistant, draft a response to Ed assuming the recalculation were accurate and still produced the same outcome as before.
Task 3: Product and service costing systems
Jack Halpern is the owner and CEO of Aerospace Comfort, a firm specialising in the manufacture of seats for aeroplanes. He has just received a copy of a letter written to the general audit section of the RAAF. He believes it is from an ex-employee of Aerospace Comfort.
Dear Sir,
Aerospace Comfort manufactured 100 X7 seats for the RAAF in 2014. The following may be of interest:
1. Direct materials costs billed for the 100 X7 seats were $25000.
2. Direct manufacturing labour costs billed for 100 X7 seats were $6000. These costs include 16 hours of set-up labour atS25 per hour, an amount included in the manufacturing overhead cost pool as well. The 56000 also includes 12 hours of design time at S50 an hour. Design time was explicitly identified as a cost the RAAF would not reimburse.
3. Manufacturing overhead costs billed for 100 X7 seats were $9000 (150% of direct manufacturing labour costs). This amount includes the 16 hours of set¬up labour at $25 per hour that is incorrectly included as part of direct manufacturing labour costs.
You may also want to know that over 40% of the direct materials is purchased from Frontier Technology, a company that is 51°1'0 owned by Jack Halpern's brother. For obvious reasons, this letter will not be signed. cc: The Australian, Jack Halpern, CEO of Aerospace Comfort Aerospace Comfort's contract states that the RAAF reimburses Aerospace Comfort at 130% of total manufacturing costs.
Assume that the facts in the letter are correct as you answer the following questions. Required
1 What is the cost amount per X7 seat that Aerospace Comfort billed the RAAF? Assume that the actual direct materials costs were $25 000.
2 What is the amount per X7 seat that Aerospace Comfort should have billed the RAAF? Assume that the actual direct materials costs were $25000.
3 What should the RAAF do to tighten its procurement procedures to reduce the likelihood of such situations recurring in the future?