Problem 1 - Make or Buy Decision
Easyuse Tool Co. manufactures an electric motor that it uses in several of its products. Management is considering whether to continue manufacturing the motors or to buy them from an outside source. The following information is available.
1. The company needs 12,000 motors per year. The motors can be purchased from an outside supplier at a cost of $21 per unit.
2. The unit cost of manufacturing the motors is $35, computed as follows.
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Direct materials
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$96,000
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Direct labor
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120,000
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Factory overhead:
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Variable
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90,000
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Fixed
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114,000
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Total manufacturing costs
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$420,000
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Cost per unit ($420,000 ÷ 12,000 units)
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$35
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3. Discontinuing the manufacture of motors will eliminate all the raw materials and direct labor costs but will eliminate only 75 percent of the variable factory overhead costs.
4. If the motors are purchased from an outside source, machinery used in the production of motors will be sold at its book value. Accordingly, no gain or loss will be recognized. The sale of this machinery would also eliminate $6,000 in fixed costs associated with depreciation and taxes. No other reductions in fixed factory overhead will result from discontinuing the production of motors.
Instructions -
a. Prepare a schedule to determine the incremental cost or benefit of buying the motors from the outside supplier. Using this schedule, would you recommend that the company manufacture the motors or buy them from the outside source?
b. Assume that if the motors are purchased from the outside source, the factory space previously used to produce motors can be used to manufacture an additional 4,000 power trimmers per year. Power trimmers have an estimated contribution margin of $8 per unit. The manufacture of the additional power trimmers would have no effect on fixed factory overhead. Would this new assumption change your recommendation as to whether to make or buy the motors? In support of your conclusion, prepare a schedule showing the incremental cost or benefit of buying the motors from the outside source and using the factory space to produce additional power trimmers.
Problem 2 - Sell or Rebuild Decision
Silent Sentry manufactures gas leak detectors that are sold to homeowners throughout the United States at $25 apiece. Each detector is equipped with a sensory cell that is guaranteed to last two full years before needing to be replaced. The company currently has 50,000 gas leak detectors in its inventory that contain sensory cells that had been purchased from a discount vendor. Silent Sentry engineers estimate that these sensory cells will last only 18 months before needing to be replaced. The company has incurred the following unit costs related to the 50,000 detectors.
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Direct materials
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$10
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Direct labor
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2
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Variable overhead
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3
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Fixed overhead
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1
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Total
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$16
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Silent Sentry is currently evaluating three options regarding the 50,000 detectors.
1. Scrap the inferior sensory cell in each unit and replace it with a new one at a cost of $8 each. The units could then be sold at their full unit price of $25.
2. Sell the units with the inferior sensory cells at a discounted unit price of $24. This option would also involve changing the packaging of each unit to inform the buyer that the estimated life of the sensory cell is 18 months. The estimated out-of-pocket cost associated with the packaging changes is $3 per unit.
3. Sell each unit "as is" with its current packaging to a discount buyer in a foreign country. The buyer has offered to pay Silent Sentry a unit price of $22.
Instructions -
a. Perform an incremental analysis of these options. Based on the analysis, which option should Silent Sentry choose?
b. What non-financial concerns should the company take into consideration?
Problem 3 - The Gilster Company
The Gilster Company, a machine tooling firm, has several plants. One plant, located in St. Falls, Minnesota, uses a job order costing system for its batch production processes. The St. Falls plant has two departments through which most jobs pass. Plantwide overhead, which includes the plant manager's salary, accounting personnel, cafeteria, and human resources, is budgeted at $250,000. During the past year, actual plantwide overhead was $240,000. Each department's overhead consists primarily of depreciation and other machine-related expenses. Selected budgeted and actual data from the St. Falls plant for the past year are as follows.
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Department A
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Department B
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Budgeted department overhead (excludes plantwide overhead)
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$150,000
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$600,000
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Actual department overhead
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160,000
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620,000
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Expected total activity:
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Direct labor hours
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35,000
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15,000
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Machine-hours
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10,000
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40,000
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Actual activity:
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Direct labor hours
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51,000
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9,000
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Machine-hours
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10,500
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42,000
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For the coining year, the accountants at St. Falls are in the process of helping the sales force create bids for several jobs. Projected data pertaining only to job no. 110 are as follows.
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Direct materials
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$25,000
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Direct labor cost:
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Department A (2,200 hr)
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45,000
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Department B (800 hr)
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10,000
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Machine-hours projected:
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Department A
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200
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Department B
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1,200
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Units produced
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10,000
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Instructions -
a. Assume the St. Falls plant uses a single plantwide overhead rate to assign all overhead (plantwide and department) costs to jobs. Use expected total direct labor hours to compute the overhead rate. What is the expected cost per unit produced for job no. 110?
b. Recalculate the projected manufacturing costs for job no. 110 using three separate rates: one rate for plantwide overhead and two separate department overhead rates, all based on machine-hours.
c. The sales policy at St. Falls dictates that job bids be calculated by adding 40 percent to total manufacturing costs. What would be the bid for job no. 110 using (1) the overhead rate from part a and (2) the overhead rate from part b? Explain why the bids differ. Which of the overhead allocation methods would you recommend and why?
d. Using the allocation rates in part b, compute the under- or overapplied overhead for the St. Falls plant for the year. Explain the impact on net income of assigning the under- or overapplied overhead to cost of goods sold rather than prorating the amount between inventories and cost of goods sold.
e. A St. Falls subcontractor has offered to produce the parts for job no. 110 for a price of $12 per unit. Assume the St. Falls sales force has already committed to the bid price based on the calculations in part b. Should St. Falls buy the $12 per unit part from the subcontractor or continue to make the parts for job no. 110 itself?