Author Question: Make or buy, unknown level of volume. (A. Atkinson, adapted) Denver Engineering manufactures ... (Read 74 times)

NguyenJ · **on:** Jul 6, 2018

Make or buy, unknown level of volume.

(A. Atkinson, adapted) Denver Engineering manufactures small engines that it sells to manufacturers who install them in products such as lawn mowers. The company currently manufactures all the parts used in these engines but is considering a proposal from an external supplier who wishes to supply the starter assemblies used in these engines.
The starter assemblies are currently manufactured in Division 3 of Denver Engineering. The costs relating to the starter assemblies for the past 12 months were as follows:

Over the past year, Division 3 manufactured 150,000 starter assemblies. The average cost for each starter assembly is 10(1,500,000 150,000).
Further analysis of manufacturing overhead revealed the following information. Of the total manufacturing overhead, only 25 is considered variable. Of the fixed portion, 300,000 is an allocation of general overhead that will remain unchanged for the company as a whole if production of the starter assemblies is discontinued. A further 200,000 of the fixed overhead is avoidable if production of the starter assemblies is discontinued. The balance of the current fixed overhead, 100,000, is the division manager's salary. If Denver Engineering discontinues production of the starter assemblies, the manager of Division 3 will be transferred to Division 2 at the same salary. This move will allow the company to save the 80,000 salary that would otherwise be paid to attract an outsider to this position.

Required:
1. Tutwiler Electronics, a reliable supplier, has offered to supply starter-assembly units at 8 per unit. Because this price is less than the current average cost of 10 per unit, the vice president of manufacturing is eager to accept this offer. On the basis of financial considerations alone, should Denver Engineering accept the outside offer? Show your calculations. (Hint: Production output in the coming year may be different from production output in the past year.)
2. How, if at all, would your response to requirement 1 change if the company could use the vacated plant space for storage and, in so doing, avoid 100,000 of outside storage charges currently incurred? Why is this information relevant or irrelevant?

Question 2

Ready Company received a bill for advertising. The accountant would record a
a. credit to cash.
b. credit to accounts receivable.
c. credit to accounts payable.
d. credit to advertising expense.

meryzewe · **Reply #1 on:** Jul 6, 2018

Answer to Question 1

1. The variable costs required to manufacture 150,000 starter assemblies are

Direct materials 400,000
Direct manufacturing labor 300,000
Variable manufacturing overhead 200,000
Total variable costs 900,000

The variable costs per unit are 900,000 150,000 = 6.00 per unit.

Let X = number of starter assemblies required in the next 12 months.

The data can be presented in both all data and relevant data formats:

All Data Relevant Data
Alternative 1:
Make Alternative 2:
Buy Alternative 1:
Make Alternative 2: Buy
Variable manufacturing costs
Fixed general manufacturing overhead
Fixed overhead, avoidable
Division 2 manager's salary
Division 3 manager's salary
Purchase cost, if bought from
Tutwiler Electronics
Total costs
6X
300,000
200,000
80,000
100,000

680,000
+ 6X
300,000

100,000

8X
400,000
+ 8X 6X

200,000
80,000
100,000

380,000
+ 6X

100,000

8X
100,000
+ 8X

The number of units at which the costs of make and buy are equivalent is

All data analysis: 680,000 + 6X = 400,000 + 8X
2X = 280,000
X = 140,000
or
Relevant data analysis: 380,000 + 6X = 100,000 + 8X
2X = 280,000
X = 140,000

Assuming cost minimization is the objective, then
If production is expected to be less than 140,000 units, it is preferable to buy units from Tutwiler.
If production is expected to exceed 140,000 units, it is preferable to manufacture internally (make) the units.
If production is expected to be 140,000 units, Denver should be indifferent between buying units from Tutwiler and manufacturing (making) the units internally.

2. The information on the storage cost, which is avoidable if self-manufacture is discontinued, is relevant; these storage charges represent current outlays that are avoidable if self-manufacture is discontinued. Assume these 100,000 charges are represented as an opportunity cost of the make alternative. The costs of internal manufacture that incorporate this 100,000 opportunity cost are

All data analysis: 780,000 + 6X
Relevant data analysis: 480,000 + 6X

Alternatively stated, we would add the following line to the table shown in requirement 1 causing the total costs line to change as follows:

All Data Relevant Data
Alternative 1: Alternative 2: Alternative 1: Alternative 2:
Make Buy Make Buy
Outside storage charges 100,000 0 100,000 0
Total costs 780,0001 + 6X 400,000 + 8X 480,0002 + 6X 100,000 + 8X

1780,000 = 680,000 + 100,000 2480,000 = 380,000 + 100,000

The number of units at which the costs of make and buy are equivalent is

All data analysis: 780,000 + 6X = 400,000 + 8X
2X = 380,000
X = 190,000

Relevant data analysis: 480,000 + 6X = 100,000 + 8X
2X = 380,000
X = 190,000

If production is expected to be less than 190,000, it is preferable to buy units from Tutwiler. If production is expected to exceed 190,000, it is preferable to manufacture the units internally.

Answer to Question 2

C