Question

Quality Water boards, Inc., currently produces surfboards. Management is interested in outsourcing production of these surfboards to a reputable manufacturing company that can supply the surfboards for $630 per unit. Quality Water boards incurs the following annual production costs to produce 2,100 Quality Water Boards:

	Per unit	Total annual cost of 2,100 units
Variable production costs
Direct materials	420	$882,000
Direct labor	105	220,500
Manufacturing overhead	53	111,300
Fixed production costs
Factory building and equipment lease
Factory insurance		189,000
Production supervisor's salary		63,000
Total production costs		73,500
		$1,539,300

Outsourcing production eliminates all variable production costs, the production supervisor's salary, and factory insurance costs. Factory building and equipment lease costs will remain the same regardless of the decision to outsource or to produce internally.

1. Perform differential analysis Assume that making the surfboards internally is Alternative 1 and that buying the surfboards from an outside manufacturer is Alternative 2.
2. Which alternative is best? Explain.

Answer 1

Differential Cost Analysis
	Amount ($)
Avoidable cost under alternative 1	1,350,300.00
Less: Buying cost under alternative 2 ($ 630*2100)	1,323,000.00
Reduction in cost under alternative 2	27,300.00
Alternative 2 should be selected as it result in lower cost by $ 27300

Calculation of avoidable cost
	Amount ($)
Direct Material	882000
Direct Labor	220500
Manufacturing Overhead	111300
Production Supervisor's salary	73500
Factory Insurance cost	63000
	1350300

Notes:
Cost which are not affected by the decision shall not be taken into account