Question

Pottery Crane 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 61% of direct labor cost. The direct materials and direct labor cost per unit to make a pair of finials are $4 and $5, respectively. Normal production is 33,300 curtain rods per year. A supplier offers to make a pair of finials at a price of $13.16 per unit. If Pottery Ranch accepts the supplierâs 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 Pottery Ranch should buy the finials.
b. Should Pottery Ranch buy the finials?
c. Would your answer be different in (b) if the productive capacity released by not making the finials could be used to produce income of $50,367?

Answer 1

Answer: See explanation

Explanation:

a. Direct material = 4 × 33300 = Make $133200 ; Net income increase

Direct labor = 5 × 33300 = Make $166500 ; Net income increase

Variable costing= 0.61 × $166500 = Make $101565 ; Net income increase

Fixed manufacturing = Make 43100 ; Buy 43100 ;

Purchase price = 13.16 × 33300 = Buy $438228 ; Net income decrease

Total annual cost:

Make: $444365

Buy: $481328

Net income decrease = $36963

b. No, Pottery Ranch should not buy the finials. There's an incremental cost of $36963.

c. Incremental revenue = $50,367

Incremental cost = $36963

Incremental revenue = $50367 - $36963 = $13404

In this case, it should be bought.