Accounting

DESCRIPTION OF THE COMPANY AND INDUSTRY
Starnet is medium sized company and is engaged in the production and sale of various electrical appliances that are for industrial and domestic use. The average life of the appliances sold by Starnet is six years. As per the norms of the industry all the products sold by the companies are to be covered under warranty for a specific time period.

SITUATION ANALYSIS
The company provides a warranty period of one year on all of its products. The terms and conditions of the warranty agreement include a free after sales service, including parts. Thereafter, all the services are provided at market rates.

The company is currently providing after sales services through a servicing consultant, Delta Inc. The terms and conditions of the agreement between Starnet and Delta Inc. are as under
For all the repairs carried out under the warranty period
The material required will be provided by Starnet.

Labor and overheads on services provided will be incurred by Delta Inc and will be billed to Starnet at cost plus a markup of 30.

For all the repairs carried out after the warranty period
The material required will be supplied by Starnet to Delta inc. at cost plus a mark-up of 15.

Starnet gets a share in all amounts billed to the customers after the warranty period. 10 share is received in respect of amounts billed to industrial customers and 15 in case of domestic customers.

DECISION FACED
The management of Starnet is now considering the possibility of providing the services directly instead of outsourcing them to Delta Inc.

The Following information was compiled by the management accountant of the company in respect of the previous year
20 of the services were provided to domestic customers and 80 to industrial customers.
Mark-up billed to Delta Inc amounted to  860,000.

An amount of  990,000 was received from Delta being the Starnets share of amount billed to the customers.
Total amount of material billed to customers by Starnet amounted  500,000. It has been estimated that the cost of material billed by Starnet, to the customers, is determined by applying a further mark-up of 25 over the amount billed by Delta.

It is estimated that the cost of labor and variable overheads will increase by 10, if the services are provided by Starnet. However, Starnet will not be able to pass on this increase to the customers. Moreover, a supervisor will have to be appointed to oversee the process, at a consolidated salary of  4,000 per month. Other fixed overheads will also increase by  2,000 per month.

MANAGERIAL ACCOUNTING PERSPECTIVE
The company should decide between rendering the repair services through its servicing consultant or providing such services itself by comparing the total actual cost and revenues under both the options.

However the choice of the decision will depend on clear identification of the relevant costs by the company.
The analysis of the relevant costs will include identification of the costs that are different in the alternatives or in other words ignoring the costs that are common under both the options.

The company should then use the total amount of revenue under each alternative to select the best among the two given choices, i.e. the choice that earns the maximum revenue for the company should be adapted by the company.