The controller of a German machine tool company believed that historical cost depreciation was inadequate for assigning the cost of using expensive machinery to individual parts and products. Each year, he estimated the replacement cost of each machine and included depreciation based on the machine’s replacement cost in the machine-hour rate used to assign machine expenses to the parts produced on that machine. Additionally, the controller included an interest charge, based on 50% of the machine’s replacement value, into the machine-hour rate. The interest rate was an average of the three- to five-year interest rate on government and high-grade corporate securities.
As a consequence of these two decisions (charging replacement cost rather than historical cost and imputing a capital charge for the use of capital equipment), the product cost figures used internally by company managers were inconsistent with the numbers that were needed for inventory valuation for financial and tax reporting. The accounting staff had to perform a tedious reconciliation process at the end of each year to back out the interest and replacement value costs from the cost of goods sold and inventory values before they could prepare the financial statements.
Required
(a) Why would the controller introduce additional complications into the company’s costing system by assigning replacement value depreciation costs and imputed interest costs to the company’s parts and products?
(b) Why should management accountants create extra work for the organization by deliberately adopting policies for internal costing that violate the generally accepted accounting principles that must be used for external reporting?