Exercise 7-5 Pottery Ranch Inc. has been manufacturing Its own finials for Its c

Question

Exercise 7-5 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 50% of direct labor cost. The direct materials and direct labor cost per unit to make a pair of finials are $3.50 and $4.50, respectively. Normal production is 25,000 curtain rods per year. A supplier offers to make a pair of finials at a price of $12.75 per unit. If Pottery Ranch accepts the supplier?s offer, all variable manufacturing costs will be eliminated, but the $40,000 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. (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 $67,000?

Explanation / Answer

(a) Preparation of incremental analysis to decide make or buy.

(b) Since, the net income decrease by $ 62,500 if company buy the product.Therfore Pottery Ranch Inc. should not buy the fnials rod.

(c) If income earned $ 67,000 . Then answer in (b) above shall change.In this situation,

Income would increase by $ 4,500(67,000 - 62,500).

Particulars Make Buy Net income (increase / Decrease) Material 25,000 x 3.50 $ 87,500 0 $ 87,500 Labour 25,000 x 4.50 112,500 0 112,500 Variable overhead Costs 50 % of 112,500 56,250 0 56,250 Fixed overhead costs 40,000 40,000 0 Purchase price 0 25,000 x 12.75 318,750 - 318,750 Total annual costs $ 296,250 $ 358,750 - $ 62,500

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