Question 12.8: Modern Producers Ltd has, like virtually all manufacturers, ...
Modern Producers Ltd has, like virtually all manufacturers, a separate area for finished goods. the costs of running the stores include a share of the factory rent and other establishment costs, such as heating and lighting. They also include salaries of staff in charge of the inventory, and the cost of financing the stored inventory.
The business has two product lines, product A and product B. Product A tends to be made in small batches, and so low levels of finished goods inventories are held. The business prides itself on its ability to supply product B in relatively large quantities instantly, so much of the stores is filled with finished stocks of product B ready to be dispatched immediately an order is received.
Traditionally, the whole cost of operating the stores has been treated as a general overhead and included in the total of overheads that is charged to jobs, probably on a direct labour hour basis. This means that when assessing the cost of products A and B, the cost of operating the stores has fallen on them according to the number of direct labour hours worked on each one. In fact, most of the stores’ cost should be charged to product B, since this product causes (and benefits) from the stores’ cost much more than product A does.
Failure to account more precisely for the costs of running the stores is masking the fact that product B is not as profitable as it seems; it may even be causing losses due to the relatively high costs of storing it. So far, much of this cost has been charged to product A, even though product A incurs little of the cost. This product absorbs the stores’ costs (in its production costs) in proportion to the direct labour hour content, a factor which has nothing to do with storage.