Question

Arigold Inc. has been manufacturing its own finials for its curtain rods. The company is currently operating at 100% of capacity, and variable manufacturing overhead is charged to production at the rate of 62% of direct labor cost. The direct materials and direct labor cost per unit to make a pair of finials are $3.98 and $4.78, respectively. Normal production is 30,400 curtain rods per year. A supplier offers to make a pair of finials at a price of $13.16 per unit. If Marigold accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $43,100 of fixed manufacturing overhead currently being charged to the finials will have to be absorbed by other products.Required:a. Prepare an incremental analysis to decide if Arigold Inc should buy the finials.b. Should Arigold Inc. buy the finials?

Answer 1

Answer:

Arigold Inc's Finials' Incremental Analysis:

a-i) To buy Finials, the price is $13.16 per unit.

a-ii) To make Finials, the relevant cost per unit is calculated as follows:

Materials = $3.98 per unit

Labor = $4.78 per unit

Variable Overhead = 62% of Labour cost, = 0.62 x $4.78 = $2,96

Therefore, total cost per unit is $(3.98 +4.78 + 2.96) = $11.72

b) Comparing the purchase cost of $13.16 and the make cost of $11.72 per unit, Arigold Inc should not buy the Finials.

Even when the fixed manufacturing overhead is charged to the Finials, the total unit cost (absorbed) will be $13,14, which is still less than the make cost of $13.16 per unit.

Explanation:

Incremental Analysis is a business technique that assists in making decisions among choices as it shows the true differences between alternatives.  It is also known as the relevant cost approach, differential, and marginal analysis.

In the case of Arigold Inc, we disregarded the sunk or fixed manufacturing overhead of $43,100.  This is cost is not relevant in this type of decision because it would still be incurred no matter the decision taken.