Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 23

Cost Data for Managerial Purposes

Graphic Components (GC) has offered to supply the Federal Aviation Agency (FAA) with computer monitors at “cost plus 20 percent.” GC operates a manufacturing plant that can produce 22,000 monitors per year, but it normally produces 20,000. The costs to produce 20,000 monitors follow:

	Total Cost	Cost per Case
Production costs:
Materials	$ 1,000,000	$ 50
Labor	2,000,000	100
Supplies and other costs that will vary with production . .	600,000	30
Indirect cost that will not vary with production	600,000	30
Variable marketing costs	400,000	20
Administrative costs (all fixed)	1,200,000	60
Totals	$ 5,800,000	$290

Based on these data, company management expects to receive $348 (= $290 × 120 percent) per monitor for those sold on this contract. After completing 500 monitors, the company sent a bill (invoice) to the government for $174,000 (= 500 monitors × $348 per monitor).

The president of the company received a call from an FAA representative, who stated that the per monitor cost should be

Materials	$ 50
Labor	100
Supplies and other costs that will vary with production	30
	$180

Therefore, the price per monitor should be $216 (= $180 × 120 percent). The FAA ignored marketing costs because the contract bypassed the usual selling channels.

Required

What price would you recommend? Why?(Note:You need not limit yourself to the costs selected by the company or by the government agent.)

Step 1 of 7

This problem demonstrates the ambiguity of cost-based contracting and, indeed, the measurement of “cost.” This problem can stimulate a lively discussion in class.

Recommended prices may range from the $216 suggested by the FAA to the $348 charged by Graphic Components. The key is to negotiate the cost-based price prior to the signing of the contract. Considerations that affect the base costs are reflected in the following options:

Options:

A.?Only the differential production costs could be considered as the cost basis.