Solution Commentary: Acct 2220 Exercise 6-2A (Pg 227)

Outsourcing Decision for the Castro Company: / Is the Cost Relevant? / Cost Behavior? / Cost Hierarchy?
Cost Items on the Inc Stmt: / (pg 206) / (Chp 2,3) / (pg 208)
Materials cost ($9 per unit) / Relevant / Variable / Unit-level
Company president’s salary / Fixed / Facility Level
Depr on Mfg equipment* / Fixed / Product Level
Cust bill costs (1% of sales) / Variable / Batch Level?
Rental cost of mfg facility / Relevant? / Fixed / Facility level
Advertising ($200,000/yr) / Fixed / Product level
Labor cost ($8 per unit) / Relevant / Variable / Unit-level
Sales comm (1.5% of sales) / Variable / Unit-level
Salaries of admin personnel / Fixed / Facility Level
Ship handling ($0.50/unit) / Variable / Unit-level
Depr on office furniture* / Fixed / Facility Level
Mfg supplies ($0.25 per unit) / Relevant / Variable / Unit-level
Prod supervisor’s salary / Relevant / Fixed / Product Level

For this decision (i.e. the potential outsourcing of the production function), all unit-level manufacturing costs (materials, labor, manufacturing supplies) are relevant because they could be avoided (= relevant) if the products were purchased instead of manufactured.

Similarly, it is highly probable that the product-sustaining and facility-sustaining costs that are associated with making the products (i.e. production supervisor’s salary and rental of manufacturing facility) can be avoided as well.

In contrast, selling expenses and administrative costs (president’s and other administrators’ salaries, billing cost, advertising, sales commissions, shipping and handling) are not avoidable because Lopez will continue to incur these costs regardless of whether it makes the product or buys it from a supplier. Accordingly, these costs are irrelevant to this outsourcing decision.

* The depreciation expense on the manufacturing equipment and office furniture is not relevant. These expenses represent sunk costs that cannot be avoided (they have already been incurred). The only relevant information here might be any market (resale) value of the mfg equip.