Question

Scenario 1: Annette Mennard, the new plant manager of Plant A at Bass Fishing Manufacturing Co., has just reviewed a draft of her year-end financial statements for Plant A. Mennard receives a year-end bonus of 8% of the plant's operating income before tax. The year-end income statement provided by the plant's controller was disappointing to say the least. After reviewing the numbers, Mennard demanded that her controller go back and “work the numbers” again. Mennard insisted that if she didn't see a better operating income number the next time around she might consider looking for a new controller. Bass Fishing Manufacturing Co. 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 $4,340,000, are classified as period expenses. Mennard had suggested that warehousing costs be included as product costs because they are “definitely related to our product.” The company produced 400,000 units during the period and sold 370,000 units. As the controller reworked the numbers, he discovered that if he included warehousing costs as product costs, he could improve operating income by $325,500. He was also sure these new numbers would make Mennard happy. Scenario 1 required questions: 1. Explain why reclassifying the finished goods warehousing costs as a product cost instead of a period expense would affect the plant's operating income. Your explanation should include a supporting calculation that shows how operating income would improve by $325,500 just by classifying the preceding costs as product costs instead of period expenses. 2. Is Mennard correct in her justification that these costs are “definitely related to our product”? Should these finished goods warehousing costs be reclassified? Why or why not?

Answer 1

Answer

1. Reclassification of finished goods warehousing costs as product costs instead of period costs will affect plant's operating income. Generally inventory is valued using product cost. If period expense is also treated as product cost the value of inventory will increase.

As a result plant's operating income will also improve.

Finished goods warehousing cost = $4340000

No of units produced = 400000 units

No of units sold = 370000 units

Closing stock/ inventory = 30000 units

In the given scenario warehousing cost is treated as product cost, therefore the amount to be apportioned to inventory is ($4340000*30000/400000) = $325500

Hence the operating income would improve by $325500 just by classifying the warehousing costs as product cost instead of period expenses.

2. Product cost refers to the costs incurred to create a product.

In the given scenario warehousing costs are incurred by the company after the manufacturing of the product.These costs cannot be taken as product cost even though it is definitely related to a product since it is a manufacturing company.

Warehousing costs related to finished goods are included in period costs and are not included in inventory costs.

However if the warehousing costs relating to raw material and work in process inventory can be treated as part of inventory cost.

Hence Mennard is not correct in her justification that these costs are definitely related to a product. Therefore finished goods warehousing costs cannot be reclassified as product cost instead of period expenses.