Question

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

Direct materials cost for the new product will total $80 per unit. To have a place to store finished units of product, the company will rent a small warehouse nearby. The rental cost will be $500 per month. In addition, the company must rent equipment for use in producing the new product; the rental cost will be $4,000 per month. Workers will be hired to manufacture the new product, with direct labor cost amounting to $60 per unit. The space in the annex will continue to be depreciated on a straight-line basis, as in prior years. This depreciation is $8,000 per year.

Advertising costs for the new product will total $50,000 per year. A supervisor will be hired to oversee production; her salary will be $3,500 per month. Electricity for operating machines will be $1.20 per unit. Costs 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 about $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 1), indicate whether the cost is fixed or variable. With respect to cost classifications for manufacturers (column 2), 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 3), indicate whether the item is a product cost or period cost. Finally, in terms of cost classifications for decision making (column 4), 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 1-3.

Answer 1

	Column 1	Column 2	Column 3	Column 4
Name of the cost	Predicting Cost Behavior	Manufacturers	Preparing Financial statements	Decision Making
Rental revenue forgone, $30,000 per year	None	None	None	Opportunity cost
Direct materials cost, $80 per unit	Variable cost	Direct material	Product
Rental cost of warehouse $500 per month	Fixed Cost	None	Period
Rental cost of equipment, $4,000 per month	Fixed Cost	Manufacturing overhead	Product
Direct labor cost, $60 per unit	Variable cost	Direct labor	Product
Depreciation of the building, $8,000 per year	Fixed Cost	Manufacturing overhead	Product	Sunk cost
Advertising cost, $50,000 per year	Fixed Cost	none	Period
Supervisor's salary, $3,500 per month	Fixed Cost	Manufacturing overhead	Product
Electricity for machines, $1.20 per unit	Variable cost	Manufacturing overhead	Product
Shipping cost, $9 per unit	Variable cost	none	Period
Return earned on investments, $3,000 per year	none	none	none	Opportunity cost