Question

Wollogong Group Ltd. of New South Wales, Australia, acquired its factory building 10 years ago. For several years, the company has rented out a small annex attached to the rear of the building for $30,000 per year. The renter’s lease will expire soon, and rather than renewing the lease, the company has decided to use the annex to manufacture a new product.

Direct materials cost for the new product will total $80 per unit. To have a place to store its finished goods, the company will rent a small warehouse for $500 per month. In addition, the company must rent equipment for $4,000 per month to produce the new product. Direct laborers will be hired and paid $60 per unit to manufacture the new product. As in prior years, the space in the annex will continue to be depreciated at $8,000 per year.

The annual advertising cost for the new product will be $50,000. A supervisor will be hired and paid $3,500 per month to oversee production. Electricity for operating machines will be $1.20 per unit. The cost of shipping the new product to customers will be $9 per unit.

To provide funds to purchase materials, meet payrolls, and so forth, the company will have to liquidate some temporary investments. These investments are presently yielding a return of $3,000 per year.

Required:
Using the table shown below, describe each of the costs associated with the new product decision in four ways. In terms of cost classifications for predicting cost behavior (column 2), indicate whether the cost is fixed or variable. With respect to cost classifications for manufacturers (column 3), if the item is a manufacturing cost, indicate whether it is direct materials, direct labor, or manufacturing overhead. If it is a nonmanufacturing cost, then select “none” as your answer. With respect to cost classifications for preparing financial statements (column 4), indicate whether the item is a product cost or period cost. Finally, in terms of cost classifications for decision making (column 5), identify any items that are sunk costs or opportunity costs. If you identify an item as an opportunity cost, then select “none” as your answer in columns 2-4.

Answer 1

Answer:

Explanation:

Key terms

Opportunity cost is defined as the alternative forgone towards decision making

Sunk cost are cost that is already incurred but can no longer be recovered

Variable cost are cost that varies with volume of production

Fixed cost are costs that are regular but do not depend on the volume of production

Direct materials are materials that are directly identified with a particular product

Cost item        Man.     Cost class.   Fin Statement  Decision  Making

Rentals

Forgone                                                                          Opportunity cost

Direct Mat.     Variable   Direct mat          Product

Warehouse     Fixed        Man. Overhead  Product

Equip.Rentals Fixed       Man Overhead    Product

Direct Labor   Variable    Direct labor        Product

Depreciation   Fixed           None                Period                 Sunk  

Advert              Fixed           None                 Period

Wages              Fixed        Man Overhead   Product

Electricity        Variable    Man Overhead   Product

Shipping          Variable        None               Period      

Income             None             None              None              Opportunity cost