Fran Markus is in the cost accounting group at Boats Galore, a large manufacturing company that produces customized boats and yachts. The company sometimes experiences quality problems with its fiberglass raw material, causing flawed areas in boat hulls. The problem is often fixed by reworking the flawed areas. Other times the hull is scrapped because it is too flawed, and a new hull is fabricated. The spoilage policy at Boats Galore is to charge the cost of rework and spoilage to overhead unless it arises because a hull design is particularly complicated. In those cases, the cost is assigned to the job.

Two boats currently under construction require triple the amount of materials and labor time to enhance boat security. The customer wants each hull to be able to withstand the explosion of a small bomb. It is the company’s first order with this hull construction. Because of the new design and fiber-glass process, the customer has agreed to a cost-plus contract and will pay cost plus a fixed percentage of cost. This contract assures that Boats Galore does not incur a loss from developing the enhanced security hull. This week, the third layer on one of the boat hulls had a flaw in the fiberglass. The area was reworked, after which it met the security requirements.

Fran receives weekly data on labor and materials for each boat under construction. For regular production, workers estimate the time and materials used to rework flawed fiberglass areas, and Fran adds those costs to overhead instead of recording them as a cost of the particular job. Now she needs to decide how to record the cost of rework for the enhanced security hulls. The production people are not sure whether the flaw was due to poor quality fiberglass or to the triple hull design. If Fran adds the cost to the job order, the customer will pay for the labor and supplies as part of the cost-plus price.

If she adds the cost to overhead, the cost will be spread across all jobs and only part of it will be allocated to the job having the enhanced security hulls.

The following questions will help you analyze the information for this problem. Do not turn in your answers to these questions unless your professor asks you to do so.

ANALYZE INFORMATION

A. Critique the company’s accounting policy for rework and scrap.

B. Describe uncertainties about the accounting treatment for the rework costs on the enhanced security hull job.

C. Discuss the pros and cons of alternative accounting treatments for the rework costs on this job.

REQUIRED

Suppose you are an accounting intern at Boats Galore. Fran asks you to recommend an accounting treatment for the rework costs on the enhanced security hull job. Turn in your answers to the following.

D. Write a memo to Fran with your recommendation. As you write the memo, consider what information Fran will need from you to help her make a final decision.

E. Write one or two paragraphs explaining how you decided what information to include in your memo.