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Hello.
I encountered a little conundrum in an example question from an ALP-Gold study text.
The decision involved shutting down the battery department of a phone company in favour of external supply.
The schedule of total costs for 1 million batteries produced included a figure of $250k for depreciation, of which, it was explained, $75k dollars were apportioned from Depreciation of Factory Building. We could assume the remaining $175k related to machinery used by the Battery Department.
In the end, the relevant cost calculation included this $175k for depreciation. This went against my understanding of relevant costing principles. I would have expected opportunity costs or disposal proceeds/expenses instead.
Are the exceptions such as this? If so, I have been left completely muddled. I wonder, if it’s not too much trouble, if anyone could share their understanding with me.
It is hard for me to answer without seeing the full question.
From what you have written, I would agree with you (unless the question was asking for the impact on the profit).
Big Phones makes smart phones. The company sells 1 million phones each year. Each phone includes a standard rechargeable battery. Currently, the batteries are manufactured in-house, but the company has recently received an offer from Super Batteries to supply all the batteries required for a price of $2 each.
The management accountant has prepared a schedule showing the total costs of producing 1 million batteries last year as follows:
$000
Materials 1400
Direct Labour 320
Machine Running costs 240
Depreciation 250
Other Overheads 400
Total 2610Depreciation includes depreciation of the factory building which is apportioned to each product. $75000 has been apportioned to the battery manufacturing department. If the manufacture of batteries were to be outsourced, this part of the factory would remain empty, at least in the short term.
Other overheads include a $300000 apportionment of general factory overheads that are not specific to making batteries
Required:
Determine the costs that would be saved if the offer is accepted and hence advise Big Phones whether it should continue to manufacture the batteries in-house or outsource their manufacture to Super Batteries.Solution.
$000
Materials 1400
Direct Labour 320
Machine Running costs 240
Depreciation* 175
Other Overheads* 100
Total 2235It is a rather poor question.
It is not really a relevant cost question – here the decision would be based on the net saving or extra cost per year, and depreciation is therefore relevant.
However, since the question says that the battery part of the factory would remain empty (i.e. not sold) depreciation would still have to be charged and there would be no saving in depreciation
With regard to the specific fixed costs, it is fair to assume that the 100 would not be saved if they stopped their own production of batteries.
I agree: it is a poor question.
But it is clearer to me now, I think. Your kindness is much appreciated, good Sir, thank you very much.
Sir,
My point of view. I think may be, their assumptions on machinery depreciation is , Depreciation is charged based on units produced (Those machines which are loosing value based on its use and not on the timing factor etc )But from either perspective, its still not a relevant cost by a fact that the costs are sunk.
Thanks
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