Question

Cabinets, Inc., is a large manufacturer of modular kitchen cabinets, sold primarily to builders and developers. The company uses a standard cost system. Standard production costs have been developed for each type of cabinet; these costs and any cost variances are charged to the production department. A budget also has been developed for the sales department. The sales department is credited with the gross profit on sales (measured at standard cost) and is charged with selling expenses and any variations between budgeted and actual selling expenses.

In early April, the manager of the sales department asked the production department to fill a rush order of kitchen cabinets for a tract of 120 homes. The sales manager stated that the entire order must be completed by May 31. The manager of the production department argued that an order of this size would take 12 weeks to produce. The sales manager answered, “The customer needs it on May 31, or we don't get the business. Do you want to be responsible for our losing a customer who makes orders of this size?”

Of course, the production manager did not want to take that responsibility. Therefore, he gave in and processed the rush order by having production personnel work overtime through April and May. As a result of the overtime, the performance reports for the production department in those months showed large, unfavorable labor rate variances. The production manager, who in the past had prided himself on coming in under budget, now has very ill feelings toward the sales manager. He also has stated that the production department will never again accept a rush order.

Instructions

Identify any problems that you see in the company's standard cost system or in the manner in which cost variances are assigned to the responsible managers.

Answer 1

The company follows a standard costing policy where in the a standard cost has been developed for the production department i.e. there is a standard cost for material and labour and any cost over and above these standards is an adverse variance and is charged to the production department.

The sales department has been given a target sales budget and is credited with the gross profit on sales and debited for any selling expenses . There is a stnadard set for selling expenses as well and any varaince is debited to the sales department.

The major problems I see in the company's standard costing system are as follows:

-Production and sales are complimentary functions and are not contradictory functions. The way the costs are assigned to these respective departments hs led to the creation of conflict within the oraganization.

-The production manager is only concerned with producing within a certain budget and has no incentive to boost sales as the gross profit will not be credited to his department.

-The sales manager is only concerned with higher sales volume and not the production cost as he is credited the gross profit from a sale which is also measured at standard cost and does not vary with increasing/declining production cost.

-The rush order revenue is not figured in the company's standard costing anywhere. A refined system where in the an increased labor cost would be compensated by a decreased selling expense would be more beneficial to the company.