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Chapter 18: Problem 33

Heyer Appliances assembles dishwashers at its plant in Tuscaloosa, Alabama. In February 2017,60 circulation motors that cost 110 dollars each from a new supplier who subsequently went bankrupt) were defective and had to be disposed of at zero net disposal value. Heyer Appliances was able to rework all 60 dishwashers by substituting new circulation motors purchased from one of its existing suppliers. Each replacement motor cost 125 dollars. 1\. What alternative approaches are there to account for the materials cost of reworked units? 2\. Should Heyer Appliances use the 110 dollars circulation motor or the 125 dollars motor to calculate the cost of materials reworked? Explain. 3\. What other costs might Heyer Appliances include in its analysis of the total costs of rework due to the circulation motors purchased from the (now) bankrupt supplier?

Short Answer

Expert verified
In summary, Heyer Appliances should account for the materials cost of reworked units using the Replacement Cost Method, focusing on the 125 dollars cost of the new circulation motors rather than the sunk cost of the defective motors. Additionally, they should consider other costs such as labor, shipping, administration, service calls, warranty claims, product depreciation, and potential loss of reputation and sales when analyzing the total costs of rework due to defective motors.

Step by step solution

01

Understand the situation.

Heyer Appliances has an issue with defective circulation motors which they replaced with new, more expensive motors. They need to account for the materials cost of these reworked units, and we are asked to analyze different alternatives for this accounting.
02

Alternative approaches to account for the materials cost of reworked units.

There are two main alternative approaches to account for the materials cost of reworked units: 1. Average Cost Method: Under this method, we average the cost of the defective motor and the replacement motor to allocate the cost to the reworked units. This means that the cost for each motor would be \(\frac{110 + 125}{2}\)= 117.5 dollars. 2. Replacement Cost Method: We only consider the cost of the replacement motor (125 dollars) for the materials cost of reworked units, completely disregarding the cost of the defective motor.
03

Deciding which circulation motor price to use.

Heyer Appliances should use the 125 dollars motor to calculate the cost of materials reworked. The reason for this is that the defective motor from the bankrupt supplier has already been disposed of and cannot be used. Therefore, the cost paid for those defective motors is considered to be a sunk cost 鈥� that is, a cost that has already been incurred and cannot be recovered. Thus, Heyer Appliances should focus on the cost of the replacement motors that they have actually used in reworking the dishwashers in their accounting.
04

Identifying other costs related to rework.

In analyzing the total costs of rework due to the defective circulation motors, Heyer Appliances might include the following costs in its analysis: 1. Labor cost to remove defective motors and install new ones. 2. Shipping cost to return defective motors (if any, as it is stated that the supplier is bankrupt, which may imply that it won't accept returns). 3. Administration cost associated with contacting existing suppliers, arranging for replacement motors, and handling the disposal of defective motors. 4. Costs related to any service calls, warranty claims, or other after-sales services that may arise due to the defective motors. 5. Loss of value in the finished products, as the reworked dishwashers might have suffered some damage or depreciation during the rework process. 6. Lost reputation and potential sales due to customer dissatisfaction from the defective motors. In conclusion, Heyer Appliances should use the cost of the 125 dollars replacement motor for accounting the materials cost of reworked units, as the defective motor cost is a sunk cost. They should also consider some of the additional costs mentioned to analyze the total cost of the rework process due to defective motors.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Materials Cost
Understanding materials cost is essential in cost accounting, as it represents the cost of raw materials used to produce goods. In the case of Heyer Appliances, the materials cost not only includes the purchase price of circulation motors but also considers the expense related to defective parts. When defective motors sourced from a now-bankrupt supplier resulted in a need for rework, Heyer had to determine how to calculate the materials cost for the reworked units.

There are generally two methodologies for calculating materials cost in such a scenario鈥攖he Average Cost Method and the Replacement Cost Method. The Average Cost Method would involve averaging the cost of both the defective and replacement motors, leading to a calculated cost of \(117.50 per motor. However, the Replacement Cost Method, which recommends using only the cost of the replacement motors at \)125 each, is more appropriate here. This is due to the notion that the original motors, now considered a sunk cost, do not contribute value to the reworked units and thus should not factor into the current materials cost calculation.
Sunk Cost
A sunk cost is a cost that has already been incurred and cannot be recovered. In cost accounting, it's crucial to understand that sunk costs should not affect future business decisions, as they are irrelevant to the current situation. In our exercise with Heyer Appliances, the $110 spent on the defective circulation motors represents a sunk cost. Since these motors had to be disposed of without any possibility of recouping the initial expenditure, they do not factor into the cost analysis for the reworked dishwashers.

A key reason behind categorizing such expenses as sunk costs is to avoid the 'sunk cost fallacy,' which could mislead managers into considering these past expenditures when making future financial decisions. Instead, it is more beneficial to focus on the costs that can be influenced by current choices, such as the price of the new replacement motors. By concentrating on the relevant costs, businesses can allocate their resources more efficiently and make decisions that positively impact their profitability.
Rework Accounting
Rework accounting involves tracking and analyzing the costs associated with correcting defective products. For Heyer Appliances, it includes various expenses beyond just the materials cost of the replacement motors. When accounting for rework, the company must consider several additional costs: labor for the removal and installation of motors, administration expenses, and any indirect costs related to delays or damage to reputation.

Moreover, rework can cause ripple effects, such as service calls or warranty claims, which Heyer should also consider in their total cost analysis. These are the 'hidden costs' of rework that can escalate quickly, sometimes exceeding the direct materials or labor costs involved in the repair process. Rework accounting is thus a complex task that aims to capture the entire financial impact of fixing defective products to accurately assess the profitability and operational efficiency of the business.

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Most popular questions from this chapter

Plastique produces parts for use in various industries. Plastique uses a job- costing system. The nature of its process is such that management expects normal spoilage at a rate of \(2 \%\) of good parts. Data for last month is as follows: The spoiled parts were identified after \(100 \%\) of the direct material cost was incurred. The disposal value is 2 dollars/part. 1\. Record the journal entries if the spoilage was (a) job specific or (b) common to all jobs. 2\. Comment on the differences arising from the different treatment for these two scenarios.

Flextron Company is a contract manufacturer for a variety of pharmaceutical and over-the-counter products. It has a reputation for operational excellence and boasts a normal spoilage rate of \(2 \%\) of normal input. Normal spoilage is recognized during the budgeting process and is classified as a component of manufacturing overhead when determining the overhead rate. Lynn Sanger, one of Flextron's quality control managers, obtains the following information for Job No. \(\mathrm{M} 102,\) an order from a consumer products company. The order was completed recently, just before the close of Flextron's fiscal year. The units will be delivered early in the next accounting period. A total of 128,500 units were started, and 6,000 spoiled units were rejected at final inspection, yielding 122,500 good units. Spoiled units were sold at 4 dollars per unit. Sanger indicates that all spoilage was related to this specific job. The total costs for all 128,500 units of Job No. M102 follow. The job has been completed, but the costs are yet to be transferred to Finished Goods. 1\. Calculate the unit quantities of normal and abnormal spoilage. 2\. Prepare the journal entries to account for Job No. M102, including spoilage, disposal of spoiled units, and transfer of costs to the Finished Goods account. 3\. Flextron's controller, Vince Chadwick, tells Marta Suarez, the management accountant responsible for Job No. M102, the following: "This was an unusual job. I think all 6,000 spoiled units should be considered normal." Suarez knows that the work involved in Job No. M102 was not uncommon and that Flextron's normal spoilage rate of \(2 \%\) is the appropriate benchmark. She feels Chadwick made these comments because he wants to show a higher operating income for the year. a. Prepare journal entries, similar to requirement 2, to account for Job No. M102 if all spoilage were considered normal. How will operating income be affected if all spoilage is considered normal? b. What should Suarez do in response to Chadwick's comment?

"Normal spoilage is planned spoilage." Discuss.

(L. Bamber) Barrett Kitchens produces a variety of items in accordance with special job orders from hospitals, plant cafeterias, and university dormitories. An order for 2,100 cases of mixed vegetables costs 9 dollars per case: direct materials, 4 dollars; direct manufacturing labor, 3 dollars; and manufacturing overhead allocated, 2 dollars. The manufacturing overhead rate includes a provision for normal spoilage. Consider each requirement independently. 1\. Assume that a laborer dropped 420 cases. Suppose part of the 420 cases could be sold to a nearby prison for 420 dollars cash. Prepare a journal entry to record this event. Calculate and explain briefly the unit cost of the remaining 1,680 cases. 2\. Refer to the original data. Tasters at the company reject 420 of the 2,100 cases. The 420 cases are disposed of for 840 dollars. Assume that this rejection rate is considered normal. Prepare a journal entry to record this event, and do the following: a. Calculate the unit cost if the rejection is attributable to exacting specifications of this particular job. b. Calculate the unit cost if the rejection is characteristic of the production process and is not attributable to this specific Job. c. Are unit costs the same in requirements 2 a and 2 b ? Explain your reasoning briefly. 3\. Refer to the original data. Tasters rejected 420 cases that had insufficient salt. The product can be placed in a vat, salt can be added, and the product can be reprocessed into jars. This operation, which is considered normal, will cost 420 dollars. Prepare a journal entry to record this event and do the following: a. Calculate the unit cost of all the cases if this additional cost was incurred because of the exacting specifications of this particular job. b. Calculate the unit cost of all the cases if this additional cost occurs regularly because of difficulty in seasoning. c. Are unit costs the same in requirements 3a and 3b? Explain your reasoning briefly.

SunEnergy produces solar panels. A key step in the conversion of raw silicon to a completed solar panel occurs in the assembly department, where lightweight photovoltaic cells are assembled into modules and connected on a frame. In this department, materials are added at the beginning of the process and conversion takes place uniformly. At the start of November 2017 , SunEnergy's assembly department had 2,400 panels in beginning work in process, which were \(100 \%\) complete for materials and \(40 \%\) complete for conversion costs. An additional 12,000 units were started in the department in November, and 3,600 units remain in work in process at the end of the month. These unfinished units are \(100 \%\) complete for materials and \(70 \%\) complete for conversion costs. The assembly department had 1,800 spoiled units in November. Because of the difficulty of keeping moisture out of the modules and sealing the photovoltaic cells between layers of glass, normal spoilage is approximately \(12 \%\) of good units. The department's costs for the month of November are as follows: 1\. Using the format on page 728 , compute the normal and abnormal spoilage in units for November, assuming the inspection point is at (a) the \(30 \%\) stage of completion, (b) the \(60 \%\) stage of completion, and (c) the \(100 \%\) stage of completion. 2\. Refer to your answer in requirement 1. Why are there different amounts of normal and abnormal spoilage at different inspection points? 3\. Now assume that the assembly department inspects at the \(60 \%\) stage of completion. Using the weighted-average method, calculate the cost of units transferred out, the cost of abnormal spoilage, and the cost of ending inventory for the assembly department in November.
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