Question

falsu - CASE 12-32 Make or Buy Decisions; Volume Trade-Off Decisions L012-1, L012-3, L012-5 TutStuff, Inc., sells a wide range of drums, bins, boxes, and other containers that are used in the chemical industry. One of the company's products is a heavy-duty corrosion-resistant metal drum. called the WVD drum, used to store toxic wastes. Production is constrained by the capacity of an

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Answer 1

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Reapoirergent ent . The product margins computed by the accounting department for the droms y bike frames should not be used in the decision of which product to make the product margins are lower than they should be due to the of allocated fixed common costs that are irrelevant dcasion. Moreover, even after the irrelevant costs have removed, What matters as the profitability of the two Produts in melation to the amount of the constra Welding time that they use. A product with a may be desirable if it ores very little of the consti Xelonce - In short, the financial data provided by the accounting department are useless is potentially misleaa. for making this decision. amount of the constrained resource A product with a very low margin constrained of the at : : Assuming margin follows: direct labor per unit for is a each fixed cost prodext the contribution calculated as is Requirement Manufactured particulars purchased WYD Oxums Bile frames Drums $239-00 $ 149.00 $ 149.00 138.00 Selling price (A) variable costs: Diret materials Variable mfg overhead variable selling Admin Total variable cost (B) contribution margin (A-B) - 99.40 1.90 1.30 52.10 1.35 0.75 0-00 8.75 $102.60 $54.20 $ 138.75 $94.80 $136.40 I 10.25

Assuming margin per calculated direct labor is a fixed cost welding machine hour for as follows: the each contribution product Requirements Manufactured particulars Droms frames contribution morgin Welding hours per contribution margin per onit (above) (0) Unit (b) per welding hour (a b) $ 94.80 0.4 hour $237.00 per hr $ 136-40 0.5 hour $ 272.80 perar Pequirements Because the contribution margin per unit of the constrained resoure (welding time) is larger for the bike frames than the WVD Droms, the frames make the most profitable ose of the welding machine (assuming direct labor is a fixed cost). Consequently, the company should manol as many bike frames as possible up to demand and then use any leftover capacity to produce Word Drums. Buying the drums from the outside Suppler can fill and remaining on Satished demond for WVD Drums - The necessary calculations are carried out below. Quantity unit unit welding Toral Balance contribution time welding of Total Margin Contribution . (2) XCC) time (a) (b) Total hours available 2000 Bice frames produced 1600 $136.40 0.5 800 1200 218240 WND Drums -make 3000 & 94.80 0.4 200 $ 284400 WHD Droms- buy 3000 $ 10025 30750 Total contribution margin 4533390 ress: - Contribution margin from present operations : 5000 drums x $94.80 ch per drom $(474000) Increased contribution margin egnet operating income & 89390 particolars De fimc welding

ut : Assoming margin direct per on't labor for is a variable each product is cost, the contribution catolated as Requirement G particolars purchased Manofactured WND Bike Drums WUD tram Drums 149.00 $ 149-00 $ 239.00 138-00 52-10 99.40 28.80 1.90 0.00 Selling price (A) Variable Costi? Direct Materials Direct labor Variable mfg overhead variable selling y Admin Toral variable costs (B) contribution margin (1-B) - 3.60 1-35 0.75 0.75 S 57.80 $131.40 $ 138.75 91.20 $187.60 $ 10.25 G 6: Assoming margin per as follows: direct labor welding hour is a variable for each cost product the is contribotion calculated Manufactured Requirement WVD 991.20 f 107.60 0.5 hour particulars Bike Droms frames Contribution margin per unit (a) welding hours per unit (b) 0.4 hour contribution margin per welding hour (aeb) y $228.00 $215.20 perar portir Note : when direct labor is assumed to be variable cost, the conclusion is reversed from the case in which direct labor is assumed to be fixed cost - The WND droms appears to be a better use of the constraint than the bike framers- The assumption about the behavior of direct labor really does matter

: Assoning product computed direct labor mix & increase as follows: is a variable cost, in net operating the optimal income is Requirement Balance particulars Quantity Unit Contributor Margin Welding Tool bime wong peront time of welding Toral contributio (a)x(b) time time 2 000 $456000 110760 Dos $ 10250 (b) (c) (a)xce) Total hours available WND Drums -make 000 91-20 0-4 2000 Bike frames produed WNI droms - buy looo $10025 Toral contribution margin Less :- contribution margin from present operations : 5000 dranst $91-20 cm per drom Increased contribution margin is net operating income $466250 (456000) $ 10250 The case i the bile personnel a how moch Plans- strongly suggets that direct labor is frames could be produced with existing Nevertheless, it would be a good idea labor time is really needed under the fixed. equipments to examine two opposing Requirement ® Total Direct Labor tours particulars Direct labor Hours per unit production plan le Bike frames WWD drums 1.6* 1600 3ooo 0.2 ** 2560 600 3160 plan 2 : WVD drums 5000 1000 $28.80 $3060 & & 18.00 per kra $ 18.00 perts - 106 hour Oo2 hour of

Some caution is advised - plan I assumes that direct lobo is a fixed cost. However, this plan reagoires ? labor hours than plan Ian 2.ce 2.g the the present present (3160 DLH'S si situation .- 1000 DLH'S = 2160 DLH's) At yo hours per week a typical full time employee WorlLS about 1900 hours a year, So the added woncload is equivalent to more than one full-time employer. Dous the plant really have that much i at present ? If so, and it Skifting workers over to making bitke frames would not jeopardize operations et rewhere, The plan is indeed the better plan. However, it taking on the bike trame as a new product would lead to pressore to hire another worker, more analysis is in order- It is still best to view direct labor as a fixed cost, but talking on the frames as a new product could lead to a jump in fixed costs of about $34200 ( 1900 hours 4 8 18 porty) assuming that the remaining 260 hours (2160 hoors - 1900 hours) could be made up using otherwise idle time. contribution margin plan I: (Additional analysis) Bike frames produced (1600 x $ 136.40) $ 218240 244400 WVD Droms- makke (3000 +994.80) WND Droms - buy (2000 & $ 10:25) 30750 Total contribution margin 533390 Less: Additional fixed labor costs (34200) Net effect of plan & on net operating uncome $499190 contribution margin plan ? : WND Drums - make (5ooox $94-80) WVD Drums - buy (1000 x 140.25) Net effect of plan 2 on net operating income 1 474000 10250 have to if an additional direct labor be hired , plan, is still employee would optimal.