Pottery land 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 70% 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 30,000 curtain rods per year.A supplier offers to make a pair of finials at a price of $12.95 per unit. If Pottery land accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $45,000 of fixed manufacturing overhead currently being charged to the finials will have to be absorbed by other products.(a)Prepare the incremental analysis for the decision to make or buy the finials.   Make Buy Net IncomeIncrease (Decrease) Direct materials $  $  $  Direct labor       Variable overhead costs       Fixed manufacturing costs       Purchase price       Total annual cost $  $  $  (b)Should Pottery land 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 $20,000?

Question
Asked Nov 1, 2019
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Pottery land 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 70% 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 30,000 curtain rods per year.

A supplier offers to make a pair of finials at a price of $12.95 per unit. If Pottery land accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $45,000 of fixed manufacturing overhead currently being charged to the finials will have to be absorbed by other products.

(a)

Prepare the incremental analysis for the decision to make or buy the finials. 

   

Make

 

Buy

 

Net Income
Increase (Decrease)

 

Direct materials

 

 

 

 

Direct labor

             

Variable overhead costs

             

Fixed manufacturing costs

             

Purchase price

             

Total annual cost

 

 

 

 


(b)

Should Pottery land 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 $20,000?

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Expert Answer

Step 1

a. Incremental analysis of make or buy finials:

First af all,  lets calculate the curent cost of making finial, this is attached in table A above. 

|30,000 units
Table A
In $
Per unit cost to make finials Total cost to make 30,000 unit of finials
Particulars
Direct material
120000
4
Direct labor
5
150000
Variable Manufacturing overhead (70% of direct labor)
3.5
105000
Total
375000
45,000
Fixed cost
Grand total
420000
Cost per unit
14
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|30,000 units Table A In $ Per unit cost to make finials Total cost to make 30,000 unit of finials Particulars Direct material 120000 4 Direct labor 5 150000 Variable Manufacturing overhead (70% of direct labor) 3.5 105000 Total 375000 45,000 Fixed cost Grand total 420000 Cost per unit 14

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Step 2

Now, we will see the marginal cost of finial. This means the cost that can be avoided in case the finial is bought from market. Attached is the calculation above in table B- 

in $
Table B
Calculation of Finial marginal cost of production
Total cost to make 30,000 unit of finials
120000
150000
Direct material
Direct labor
Variable Manufacturing overhead (70% of direct labor)
Total
Fixed cost
Grand total
Marginal cost per unit
105000
Not relevant
375000
12.5
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in $ Table B Calculation of Finial marginal cost of production Total cost to make 30,000 unit of finials 120000 150000 Direct material Direct labor Variable Manufacturing overhead (70% of direct labor) Total Fixed cost Grand total Marginal cost per unit 105000 Not relevant 375000 12.5

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Step 3

Using the data in table B, we can conclude that it is better to produce finial as marginal cost is $12.50  against the cost from buying from market which is ...

Marginal cost per unit- from table B of step 2
Cost of procurement from supplier
12.5
12.95
Difference
0.45
13500
Decrease in income in case finials are procured
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Marginal cost per unit- from table B of step 2 Cost of procurement from supplier 12.5 12.95 Difference 0.45 13500 Decrease in income in case finials are procured

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