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Unit 4 – Written Assignment

Case Study – A Vacuum Manufacturer

Department of Business Administration, University of the People

BUS 5110 – Managerial Accounting

Dr. Bhavesh Kumar Rathod

July 12, 2023

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Case Study – A Vacuum Manufacturer

The following is a case study analysis of a hypothetical vacuum manufacturing company.

In this given scenario, the vacuum manufacturer is considering an offer from a third party to

make the engines that this manufacturer currently builds in-house. We will utilize managerial

accounting tools to investigate the viability of this manufacturing alternative. One such tool is

differential analysis, which compares the differences in revenues and costs among alternative

courses of action; in this case, whether or not to outsource the engine component manufacturing

(Srivastav, n.d). For this scenario, we are provided with the following data:

• Annual production volume: 50,000 units

• Direct materials: $75,000 per month

• Direct labor: $100,000 per month

• Variable factory overhead: $7.50 per unit

• Fixed factory overhead: 150% of direct labor cost per unit

• Sunk Cost portion of fixed factory overhead (executive salaries, rent, depreciation, and

taxes): 75% of fixed factory overhead (Tayari, n.d.)

o Sunk costs are those that have already been incurred and no change in scenario

will affect. These costs remain regardless of which scenario the company chooses

(Tayari, n.d.)

• Vacuum sales price: $150 per unit

• Third-party wholesale price per engine: $60 per unit

Our calculations and analysis are as follows, to which we do not factor in the vacuum retail sales

price in the differential analysis; purely focusing on the cost data provided, including the

wholesale per unit cost to buy from a third party (Heisinger & Hoyle, n.d.):
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Total annual production volume in units 50,000

Variable Factory Overhead per unit $7.50

Total Variable Factory Overhead $375,000 Variable Factory OH per unit x 50,000 units

Direct Materials cost per month $75,000

Direct Labor cost per month $100,000
Total Direct Materials & Direct Labor cost per month $175,000 Direct Materials + Direct Labor cost per month
Total Direct Materials & Direct Labor cost per year $2,100,000 Total DM & DL x 12 months

Total Direct Materials cost per year $900,000 Direct Materials cost per month x 12 months

Fixed Factory Overhead @ 150% of Direct Labor Cost Per Unit 150%
Total annual production volume in units 50000
Direct Labor cost per month $100,000
Direct Labor cost per year $1,200,000 DL per month x 12 months
Direct Labor cost per unit $24 DL per year/50,000 units

Fixed Factory Overhead per unit $36 DL cost per unit x 150%
Total Fixed Factory Overhead per year $1,800,000 Fixed Factory Overhead per unit x 50,000 units

Sunk Cost Overhead % of Total Fixed Factory OH:

Executive salaries, rent, depreciation, taxes 75%
Total Fixed Factory Overhead per year $1,800,000
Sunk Cost Fixed Factory Overhead per year $1,350,000 Fixed Factory OH % x Total Fixed Factory OH

Third-Party wholesale cost per unit $60

Total Third-Party outsourcing cost $3,000,000 Wholesale cost x 50,000 units

Differential Analysis

Alternative 1 Alternative 2
(In-House Engine (Third-Party Engine Differential Amount Alternative 1 is
Manufacturing) Outsourcing)
Variable Costs per year:
Cost to buy engines outside 0 $3,000,000 ($3,000,000) Lower
Direct Materials $900,000 0 $900,000 Higher
Direct Labor $1,200,000 0 $1,200,000 Higher
Variable Overhead $375,000 0 $375,000 Higher
Fixed Costs per year:
Total Fixed Costs $1,800,000 $1,350,000 $450,000 Higher
Total Production Costs $4,275,000 $4,350,000 -$75,000 Lower
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Recommendation and Conclusion

After performing our differential analysis, we can conclude that it would be less cost-

effective for the manufacturer to purchase wholesale engine units from a third party. The main

driver of these calculations is that 75% of fixed overhead costs continue in the form of executive

salaries, rent, depreciation, and taxes, even if the manufacturer is no longer making their own

engines in-house. This is not to say that this manufacturer should completely eliminate the idea

of outsourcing components, as the delta in production costs between the two scenarios is

relatively small at $75,000. As an example, the manufacturer could consider renting out a

smaller production facility and take advantage of lower rent, or perhaps sublet the unused portion

of their facility no longer dedicated to producing engine components and effectively lower their

rent by recuperating some subleased rental income. Additionally, another third party could

potentially provide lower wholesale per-unit pricing, making it worthwhile to outsource.

There are, however, other factors that the manufacturer should take into account in any

sort of outsourcing scenario. One major consideration is the quality of the outsourced engine.

The manufacturer needs to consider if this third-party engine provider meets the same or better

quality standards (Indeed Editorial Team, 2022). Another potential impact and unknown is

whether this third party will maintain steady wholesale pricing (Indeed Editorial Team, 2022).

What if, also, this third party cannot maintain enough steady supply of the engines to meet this

manufacturer’s needs, or decides to discontinue this engine product or goes out of business?

There are also the non-monetary effects of this manufacturer shutting down its engine production

operations, and the organizational impacts such as a drop in morale in seeing employees losing

their jobs. Differential analysis offers concrete numbers to weigh into decision-making, but

ultimately, leaders need to be able to step back and see the whole picture.
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References

Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for Managers.

https://2012books.lardbucket.org/books/accounting-for-managers/index.html

Indeed Editorial Team (2022, October 19). What is differential cost? (With formula and

examples). Indeed. https://in.indeed.com/career-advice/career-development/differential-

cost

Srivastav, A. (n.d.). Differential cost. Wall Street Mojo. Retrieved July 9, 2023, from

https://www.wallstreetmojo.com/differential-cost/

Tayari, F. (n.d.). Sunk costs, opportunity costs and break-even analysis. The Pennsylvania State

University. Retrieved July 7, 2023, from https://www.e-

education.psu.edu/eme460/node/684