A. Explain, in non-accounting terms, about the nature of manufacturing costs and costing products.

B. Why can’t Jemma simply reduce her price by $15 and cover only the variable costs of production? What would you suggest Jemma should do to combat the new competition?

Jemma Simpkins began her own business manufacturing backpacks 10 years ago under the brand name Drop Dead. These are popular with secondary school and university students as they have a secure pocket for mobile phones and a hidden compartment that parents can’t find. As Jemma’s accountant, you have been responsible for determining the cost of the backpacks. Demand has been so great that Jemma has not worried about the accounting side of the business and has focused on the creative and marketing aspects.

But fashions change, and students are no longer happy with floppy backpacks and now want neon-coloured briefcases with designer graffiti printed all over them. Jemma has been wondering whether she could compete by reducing the price of the Drop Dead backpacks. Jemma decided to look through your accounting files to see what she could work out for herself, but she was confused. She can’t understand why you have been telling her that the backpacks cost $30 to make when the cost of direct material is only $8 and the cost of direct labour is $7. ‘Where did the other $15 come from and why can’t I reduce the price of the bags by $15?’ she asks.