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Written Assignment Unit 4

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lahiru madushan
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24 views

Written Assignment Unit 4

Uploaded by

lahiru madushan
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Managerial Accounting

Written Assignment Unit 4

Please describe the circumstances of the following case study and


recommend a course of action. Explain your approach to the
problem, perform relevant calculations and analysis, and formulate
a recommendation. Ensure your work and recommendation are
thoroughly supported.

Case Study:

A vacuum manufacturer has prepared the following cost data for


manufacturing one of its engine components based on the annual
production of 50,000 units.

Description Cost per Month


Direct Materials $75,000
Direct Labor $100,000
Total $175,000

In addition, variable factory overhead is applied at $7.50 per unit.


Fixed factory overhead is applied at 150% of direct labor cost per
unit. The vacuums sell for $150 each. A third party has offered to
make the engines for $60 per unit. 75% of fixed factory overhead,
which represents executive salaries, rent, depreciation, and taxes,
continue regardless of the decision. Should the company make or
buy the engines?

Superior papers will:

Perform all calculations correctly.


Articulate the approach to solving the problem, including which
financial information is relevant and not relevant.
Correctly conclude on whether the company should make or buy the
engines.
Propose other factors that should be considered when making this
decision and elaborate on whether or not those factors do or do not
support the decision.
Our approach to this case study is carrying out a “make or buy
differential analysis”.

To do that accurately, we need to outline the needed cost or


revenue data.

First, the production of 50,000 units is annual based, therefore all


data given must be annualized to get a correct calculation.

With that in mind, the following variable monthly costs, annually


would be:

Direct Materials = $75,000 * 12 = $900,000


Direct Labor = $100,000 * 12 = $1,200,000
Total = $175,000 * 12 = $2,100,000

Variable Factory Overhead = $7.50 per unit, in same vein, total


variable factory overhead = $7.50 * 50,000 = $375,000 for the
year.

Fixed factory overhead = 150% of direct labor cost per unit.

Therefore, we have to solve for direct labor cost per unit.

Total direct labor cost for the year = $1,200,000


This means that $1,200,000 = 50,000 units

The direct labor cost per unit will be

1,200,000  50,000 = $24

Fixed factory overhead (rent, lease, salary) per unit = 150% of $24
= $36

Total Annual fixed factory overhead = $36 * 50,000 = $1,800,000

This then implies that unit costs for direct materials will be $18 also

Costs to buy engines from outside / outsourcing cost = $60 * 50,000


= $3,000,000

75% fixed costs of annual fixed factory overhead = 75% * 1,800,000


= $1,350,000

While we do not necessarily need this in the analysis to follow, the


sales revenue annual = $150 per unit * 50,000 units = $7,500,000.
We do not need this because the focus of make-or-buy decisions is
on product costs, and because sales revenue is not differential to
this decision, it is not necessary to include sales revenue in the
analysis (Heisinger & Hoyle, n.d.)

Annual Production Costs Analysis from above data:

Per
Total Annual Cost
Unit
50,000 Units
Variable production costs
Direct materials $18 $900,000

Direct labor 24 1,200,000

Manufaturing overhead 7.5 375,000

Fixed production costs

Factory overhead (rent, lease,


36 1,800,000
salary)

Total production costs $4,275,000

Make-or-Buy Differential Analysis for vacuum manufacturer


Recommendation

Making the engine components internally is the best alternative.


This alternative results in total costs of $4,275,000, providing
$75,000 in savings compared to the $4,350,000 cost of outsourcing
the production of the engine components to a third-party
manufacturer.

Summary of Differential Analysis for vacuum manufacturer

Result of Outsourcing Manufacturing of Engine


Component

$3,000,0
Cost increase to buy from outside
00

Direct materials cost savings 900,000

1,200,00
Direct labor cost saving
0

Manufaturing overhead cost savings 375,000

Factory overhead cost savings 450,000

Cost increase from outsourcing to third


$75,000
party

Other factors for consideration

We do not know exactly what the factory’s space is like to know if


they could lease the space used for making the engine component
and augment for the negative impact from there, were they to
outsource. However, if such opportunity costs exists and can make
the cost increase from outsourcing considerably lesser to between
$2000 to $5000, then the management can weigh in on other
factors such as the competency of existing personnel to undertake
manufacturing the engine components, the availability of working
capital, and the cost of any loans that may be necessary to inform
their decision on whether to make or buy (Lumen Learning, n.d.-a)
References:

Heisinger, K., & Hoyle, J. B. (n.d.-a). How Are Relevant Revenues and
Costs Used to Make Decisions? Lardbucket. Retrieved July 15, 2020,
from https://2012books.lardbucket.org/books/accounting-for-
managers/s11-how-are-relevant-revenues-and-.html

Lumen Learning. (n.d.-a). 10.2 Applying Differential Analysis in


Managerial Decision Making | Managerial Accounting. Lumen.
Retrieved July 15, 2020, from
https://courses.lumenlearning.com/sac-managacct/chapter/differenti
al-analysis-and-its-application-to-managerial-decision-making/

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