Pottery Ranch Inc. has been manufacturing its own finials for its curtain rods.

Question

Pottery Ranch Inc. has been manufacturing its own finials for its curtain rods. The company is currently operating at 100% of capacity, and variable manufacturing overhead is charged to production at the rate of 57% of direct labor cost. The direct materials and direct labor cost per unit to make a pair of finials are $3.85 and $4.84, respectively. Normal production is 25,500 curtain rods per year.

A supplier offers to make a pair of finials at a price of $13.23 per unit. If Pottery Ranch accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $46,400 of fixed manufacturing overhead currently being charged to the finials will have to be absorbed by other products.

(a)

Prepare an incremental analysis to decide if Pottery Ranch should buy the finials. (Round answers to 0 decimal places, e.g. 1250. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

(b)

Should Pottery Ranch buy the finials?

(c)

Would your answer be different in (b) if the productive capacity released by not making the finials could be used to produce income of $51,421?

Make Buy Net Income
Increase (Decrease) Direct materials $ $ $ Direct labor Variable overhead costs Fixed manufacturing costs Purchase price Total annual cost $ $ $

Explanation / Answer

a)

Since Inhouse cost is less than purchase cost, finials should be produced in house and there will be saving of $1.78 ( $ 13.23-$ 11.45) per unit

Notes : Fixed overhead is ignored because it will continue to incurr irrespective of the decision of in house manufacturing or purchase

b) No the finials should not be purchased

c) Total Loss by purchasing finials = 1.78 * 25,500 = 45,390

    Total Savings by purchasing finials = $ 51,421

Net Savings = $ 51,421-$ 45,390 = $ 6,031

Hence the company should purchase finials if the productive capacity by not making the finials could be used to produce income of $ 51,421

Particulars Make ($) Buy ($) Differential ($) Direct Material 3.85 0 3.85 Direct Labor 4.84 0 4.84 Variable Overheads ( 57% of Labor Cost 2.76 0 3 Total Cost to produce inhouse 11.45 0 11.45 Purchase cost 0 13.23 -13.23

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