Kelvin Corporation’s president asks the cost accountant to create an analysis of whether the company should drop its oldest product line, which is a series of mercury-based glass thermometers that are primarily sold into the elementary school market for chemistry classes for an average price of $5.25 each. The cost accountant investigates and finds the following costs on a per-unit basis:
|
Cost Item |
Total Cost |
Relevant Cost |
|
Direct materials |
$2.25 |
$2.25 |
|
Direct labor |
0.75 |
0.75 |
|
Variable overhead |
1.00 |
1.00 |
|
Fixed overhead |
1.50 |
— |
|
Total |
$5.50 |
$4.00 |
The company intends to shut down the entire production line for these glass thermometers, so the variable overhead element of the cost will be eliminated if the product line is stopped. However, the fixed overhead cost is related to the cost of the entire facility in which the company operates, and these costs will not go away if the company drops the product line. Thus, though the total cost of a thermometer is $5.50, the cost relevant to this product elimination decision is $4.00. The $4.00 cost is less than the price being charged to customers, so the company will fare better if it retains the product line and uses its gross margins to help pay for fixed overhead.