The management of Shatner Manufacturing Company is trying to decide whether to c

Question

The management of Shatner Manufacturing Company is trying to decide whether to continue manufacturing a part or to buy it from an outside supplier. The part, called CISCO, is a component of the company’s finished product.

The following information was collected from the accounting records and production data for the year ending December 31, 2017.

1. 8,100 units of CISCO were produced in the Machining Department.
2. Variable manufacturing costs applicable to the production of each CISCO unit were:
    direct materials $ 5.10 , direct labor $ 4.89 , indirect labor $ 0.42 , utilities $ 0.35 .
3. Fixed manufacturing costs applicable to the production of CISCO were:

All variable manufacturing and direct fixed costs will be eliminated if CISCO is purchased. Allocated costs will have to be absorbed by other production departments.

4. The lowest quotation for 8,100 CISCO units from a supplier is $ 87,328 .
5. If CISCO units are purchased, freight and inspection costs would be $ 0.38 per unit, and receiving costs totaling $ 1,290 per year would be incurred by the Machining Department.

(a) Prepare an incremental analysis for CISCO. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

(b) Based on your analysis, what decision should management make?

Cost Item Direct Allocated Depreciation $ 1,900 $ 930 Property taxes 470 400 Insurance 900 640 $ 3,270 $ 1,970

Explanation / Answer

B) If the production facilities are used alternatively to generate net income of $ 3000 then also the benefit of buying from outside souces comes out to be (87156+3000) = 90156 and cost of buying is $ 91696.

So, company should continue to manufacture on its own.

Situation 1 :- Manufacture of its own Cost All Variable cost incurred on producing CISCO Fixed cost like depreciation, Taxes are general in nature and has to be incurred in any case. Situation 2 : Buy from outside supplier Cost Quotation received Situation 1 :- Manufacture of its own S.No Cost center Amount 1 Direct Material 5.10 2 Direct Labour 4.89 3 Indirect Labour 0.42 4 Utilities 0.35 10.76 No of Units produced 8100 Total cost 87156 Situation 2 : Buy from outside supplier Quotation received 87328 Add receiving cost 1290 88618 Add Freight & inspection cost 3078 Total Cost 91696 Result :- Company should manufacture the part on its own, as incremental cost of buying is much higher than cost of manufacturing Fixed expenses are general in nature, so these are allocated to various production departments. In case of eliminating any production department, these cost are not lessens, but are allocated to other active production departments

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