Question

The plant manager of Spectra Products Manufacturing Plant has just reviewed a draft of his year-end financial statements. The plant manager receives a year-end bonus of 8% of the plant's operating income before tax. The year-end income statement provided by the controller was disappointing to say the least. After reviewing the numbers, the plant manager demanded that his controller go back and "work the numbers" again. He insisted that if he didn't see a better operating income number the next time around he would be forced to look for a new controller.

Spectra Products classifies all costs directly related to the manufacturing of its product as product costs. These costs are inventoried and later expensed as costs of goods sold when the product is sold. All other expenses, including finished goods warehousing costs of $3,570,000, are classified as period expenses. The plant manager suggested that warehousing costs be included as product costs because they are "definitely related to our product". The company produced 210,000 units during the period and sold 190,000 units.

1. If the controller reworks the numbers and reclassifies the warehouse costs as product costs, how much would operating income improve? Show all calculations.

2. Is the plant manager correct in saying the warehouse costs should be reclassified because they "definitely relate to our product"? Explain your answers.

3. How much will the plant manager benefit by this decision? Should the controller reclassify the costs? Explain why or why not.

Answer 1

1.

warehousing costs of $3,570,000
Units produced 210,000 units
warehousing cost per Unit = $3,570,000 / 210,000 = $17
Units Sold = 190,000
If the controller reclassifies the warehouse costs as Product Cost, Warehousing cost for current period will be = ( 190,000 x $17) = $3230000

So, Operating income will be improved by = Total warehousing costs - Reworked warehousing costs)
= $3,570,000 - $3230000
= $ 340000

2.
No, The plant Manager is not correct.
Warehousing cost for Finish Goods is a period cost.
It is associated with time, not with manufacturing cost.
It is not directly associated with manufacturing of product.

In given case,
Warehousing cost is incurred to store the Finish Goods.
Hence, it forms part of selling expenses and should be treated as period cost.

3.
If rework is done, then manager will be benefit by $ 340000 x 8% = $27200

No. Controller shouldn't reclassify the cost.
A normal manufacturing cost should be treated as product cost. Adding warehousing cost to product cost can cause ethical dilemma as it will defy the GAAP.