Question

You are a consultant for Watch Tech, Inc., a manufacturer of fitness watches. Currently, the firm manufactures both the electrical components for the watches and the watch casing which comes in a variety of finishes. The production manager, Sarah Adler, recently received a proposal from Custom Metal Works Corporation to manufacture the watch casing for the Watch Tech, Inc. watches. Watch Tech will be able to close down its Watch Casing Department if it purchases the casings from outside. Adler asked Watch Tech's controller to prepare an analysis of the costs that could be saved if the Watch Casing Department were closed. Below are the annual cost savings from that analysis:

Building rental (The Watch Casing Department occupies one-sixth of the factory building, which Watch Tech rents for $354,000 per year): $59,000.

Salary of the Watch Casing Department supervisor: $100,000.

Sarah Adler and the controller went to lunch this week and Adler learned that Watch Tech currently spends $78,000 a year to rent storage space to store the completed watches. However, all of the storage needs could be met in the existing factory building without requiring additional storage rental if the Watch Casing Department was discontinued. Also, the Watch Casing Department supervisor would be retained by Watch Tech even if the department were closed. The supervisor would replace the manager of the assembly department who will be retiring soon. All of Watch Tech's department supervisors earn the same salary.

Part 1:

Advise Adler on her decision. What is the "real" cost of operating the Watch Casing Department? Controllable/Uncontrollable? Consider the cost of the space occupied by the Watch Casing Department and the supervisor's salary; what type of costs are these?

Part 2:

The controller was approached by his friend, John Kinney, who is the assistant supervisor of the Watch Casing Department. Kinney asked the controller to understate the cost savings of closing the Watch Casing Department because he is afraid he will be laid off if the department is closed. Kinney is hoping that the controller will understate the cost savings so that the production manager will lean towards keeping the department in operation. What are the controller's ethical responsibilities?

Answer 1

Watch Tech Inc which is a manufacturer of electrical fitness watches and watch casings. Watch Tech Inc has two departments one is production of electrical watches and other one is production of watch casings. Sarah Adler a production manager received a proposal for manufacture of watch casings for Watch Tech Inc. Watch Tech Inc will be able to close its watch casings production department if it buy the watch casings from the outside. So Sarah Adler is requesting to prepare a analysis of the cost of the watch casings department. Watch casings department occupies one sixth of total rent paid by the Watch Tech Inc

Total rent = $354000

Rent of watch casings department = 1/6 of $354000

Rent of watch casings department = $59000

Salary of supervisor of the watch casings is $100000

Rent of additional space for storage of watch casings $78000

The real cost of operating the watch casings department $59000+$100000+$78000

= $237000

The above costs (Rent of watch casings department, salary of supervisor and rent of additional storage) are controllable, if the operations of the watch casings are stopped.

The rent of watch casings department and salary of supervisor of the watch casings department are overheads which is a fixed cost.

Hence if the Watch cases Inc will be able to buy watch cases from the outside at a lower price it is advised to shut down the watch casings department.

2. The comptroller was approached by his friend John kinney who is the supervisor of the watch casings department to understate the cost savings of of the watch casings department so as to retain as supervisor for the watch casings department. In the present case the cost savings by shutting down the watch casings department is higher than the cost savings by running the watch casings department. In this case even supervisor (John Kinney) is a friend of comptroller, the comptroller has to think for the welfare of his company rather than welfare of his friend. It is against the ethical standards of the employees who worked for their organisations. Hence the comptroller should not undeestate the cost savings from shutting down the watch casings department. The John Kinney will be replaced by the manager of assembling department after his retirement.