Question

The management of Shatner Manufacturing Company is trying to decide whether to continue manufacturing a part or to buy it from an outside supplier. The part, called CISCO, 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, 2017.

1. 8,000 units of CISCO were produced in the Machining Department.

2. Variable manufacturing costs applicable to the production of each CISCO unit were: direct materials $5.00, direct labor $4.35, indirect labor $0.40, utilities $0.39.

3. Fixed manufacturing costs applicable to the production of CISCO were:

Cost Item Direct Allocated
Depreciation $1,900 $930
Property taxes 560 290
Insurance 950 590
$3,410 $1,810

All variable manufacturing and direct fixed costs will be eliminated if CISCO is purchased. Allocated costs will have to be absorbed by other production departments.

4. The lowest quotation for 8,000 CISCO units from a supplier is $81,590.

5. If CISCO units are purchased, freight and inspection costs would be $0.34 per unit, and receiving costs totaling $1,290 per year would be incurred by the Machining Department.

(a) Prepare an incremental analysis for CISCO. Your analysis should have columns for

1.

Make CISCO,
2.

Buy CISCO, and
3.

Net Income Increase/(Decrease).

(b)
Based on your analysis, what decision should management make?

(c)
Would the decision be different if Shatner Company has the opportunity to produce $3,000 of net income with the facilities currently being used to manufacture CISCO? Show computations.


(d)
What nonfinancial factors should management consider in making its decision?

Answer 1

Answer:

a)

1. Make Cisco, total cost is $74930

2. Buy Cisco, total cost is $83152

3. Net income decrease is $8222

b. Based on the above, management should continue manufacturing Cisco since the option of purchasing results in a net income decrease of $8222

C. If Shatner Company has the opportunity to produce $3,000 of net income with the facilities currently being used to manufacture CISCO, the decision will not be different because the additional income does not offset the net decrease in income.

d. Other non financial factors to be considered by management in making its decisions are:

1. The time it takes to manufacture the product.

2. The inventory of materials and work in progress

3. Difference in quality between manufactured and purchased products

4. Delay in delivery

5. Damages due to freight

Explanation:

8000 units of Cisco was produced

Variable costs:

direct materials = $5.00

Direct labor = $4.35

indirect labor = $0.40

utilities = $0.39

Total variable cost = 8000 * (5+4.35+0.4+0.39)

TVC = 8000*9.14 = $73120

Total allocated fixed cost = $1,810

Total cost = TVC + TFC

TC = 73120+1810 = $74930

If on the other hand the units are purchased, we have :

freight and inspection = $0.34 per unit

Receiving costs = $1,290 per year

Therefore total cost = 8000*(0.34) + 1290 = $1562

If the lowest quotation for 8000 units of Cisco is $81,590, therefore the total cost of purchasing the product is 81590+1562 = $83152

(a)

1. Make Cisco, total cost is $74930

2. Buy Cisco, total cost is $83152

3. Net income decrease is $8222

b. Based on the above, management should continue manufacturing Cisco since the option of purchasing results in a net income decrease of $8222

C. If Shatner Company has the opportunity to produce $3,000 of net income with the facilities currently being used to manufacture CISCO, the decision will not be different because the additional income does not offset the net decrease in income.

d. Other non financial factors to be considered by management in making its decisions are:

1. The time it takes to manufacture the product.

2. The inventory of materials and work in progress

3. Difference in quality between manufactured and purchased products

4. Delay in delivery

5. Damages due to freight