Question

The management of Xiao Manufacturing Company is trying to decide whether to continue manufacturing a part or to buy it from an outside supplier. The part, called BIZBE, 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, 2012. 1. 6,000 units of BIZBE were produced in the Machining Department 2. Variable manufacturing costs applicable to the production of each BIZBE unit were: direct materials $4.75, direct labor $4.60, indirect labor $0.45, utilities $0.35. 3. Fixed manufacturing costs applicable to the production of BIZBE were: Cost Item Direct Allocated Depreciation $1,100 $ 900 Property taxes 500 200 Insurance 900 600 $2,500 $1,700 All variable manufacturing and direct fixed costs will be eliminated if BIZBE is purchased. Allocated costs will have to be absorbed by other production departments. 4. The lowest quotation for 6,000 BIZBE units from a supplier is $66,000. 5. If BIZBE units are purchased, freight and inspection costs would be $0.30 per unit, and receiving costs totaling $750 per year would be incurred by the Machining Department. Instructions (a) Prepare an incremental analysis for BIZBE. Your analysis should have columns for (1) Make BIZBE, (2) Buy BIZBE, and (3) Net Income Increase/Decrease. (b) Based on your analysis, what decision should management make? (c) Would the decision be different if Xiao Company has the opportunity to produce $6,000 of net income with the facilities currently being used to manufacture BIZBE? Show computations. (d) What nonfinancial factors should management consider in making its decision? DI 3R

Answer 1

a) Incremental Analysis Direct Material Direct Labor Indirect Labor Utilities Depreciation Property Taxes Insurance Purchase Price Freight & Inspection Receiving Cost Make (6000 Units) Buy (6000 Units) Net Income Increase/(Decrease) (6000 x 4.75) $ 28,500.00 $ - $ 28,500.00 (6000 x 4.6) $ 27,600.00 $ - $ 27,600.00 (6000 x 0.45) $ 2,700.00 $ - $ 2,700.00 (6000 x 0.35) $ 2,100.00 $ - $ 2,100.00 (1100 + 900) $ 2,000.00 $ 900.00 $ 1,100.00 For these Fixed Costs (5000 + 200) $ 700.00 $ 200.00 $ 500.00 only allocated costs to be (900+600) $ 1,500.00 $ 600.00 $ 900.00 considered while buying. - $ 66,000.00 $(66,000.00) (6000 x 0.30) $ - $ 1,800.00 $ (1,800.00) $ 750.00 $ (750.00) $ 65,100.00 $ 70,250.00 $ (5,150.00) b) On the basis of above comparison we can see that if company buy from outside there will be decrease in net income by $ 5150. So Manageent should Continue to Make the component. Additional Income from free Facilities of components Decrease in Net Income due to Buy Net Increase/ Decrease $ 6,000.00 $ (5,150.00) $ 850.00 So if company is able to generate additional income of $ 6000 from the free facility than there will be net increase of $850 if Company goes with buying of Equipment. So company should BUY the equipment. d) Other Non Financial factors to be considered while making decision i) Quality of component to be purchased ii) Availablity of material on time so that production doesn't stop i.e. timely delivery