Question

Old Camp Company manufactures awnings for its own line of tents. The company is currently operating at capacity and has received an offer from one of its suppliers to make the 13,000 awnings it needs for $27 each. Old Camp's costs to make the awning are $14 in direct materials and $7 in direct labor. Variable manufacturing overhead is 80 percent of direct labor. If Old Camp accepts the offer, $44,000 of fixed manufacturing overhead currently being charged to the awnings will have to be absorbed by other product lines. Required: 1. Complete the incremental analysis for the decision to make or buy the awnings in the table provided below. 2. Should Old Camp continue to manufacture the awnings or should they purchase the awnings from the supplier? 3. Assuming that the capacity released by purchasing the awnings allowed Old Camp to record a profit of $22,000, should Old Camp continue to manufacture or purchase the awnings?

Answer 1

1. Incremental analysis

	Make	Buy	Net Income Increase (Decrease)
Direct Materials	$182,000	-	$182,000
Direct Labor	$91,000	-	$91,000
Variable OH	$72,800	-	$72,800
Fixed OH	-	-	-
Purchase Price	-	$351,000	($351,000)
Total	$345,800	$351,000	($5,200)

Fixed OH are not considered while making incremental analysis as they are to be incurred whether outside offer is accepted or inhouse production is continued. Therefore, it makes fixed OH irrelevant for decision making.

2. Old Camp should continue to manufacture the awnings as if they purchase the awnings from the supplier then it would result incremental loss of $5,200.

3. Old Camp should purchase the awnings from the outside supplier because purchasing the awnings will result in loss of $5,200 but it would also result in profit of $22,000 from release capacity. In net, Old Camp will get a profit of $16,800 from purchasing the awnings from outside supplier.