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Managerial Accounting: The Corners...
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Managerial Accounting: The Corners...
Use the following information for Exercises 8-38 and 8-39:
Zion Manufacturing had always made its components in-hours. However, Bryce Component Works had recently offered to supply one component, K2, at a price of $25 each. Zion uses 10,000 units of Component K2 each year. The cost per unit of this components is as follows:
8-39 Make-or-Buy Decision
Refer to the information for Zion Manufacturing above. Assume that 75% of Zion Manufacturing’s fixed overhead for Component K2 would be eliminated if that component were no longer produced.
Required:
- 1. CONCEPTUAL CONNECTION If Zion decides to purchase the component from Bryce, by how much will operating income increase or decrease? Which alternative is better?
- 2. CONCEPTUAL CONNECTION Briefly explain how increasing or decreasing the 75% figure affects Zion’s final decision to make or purchase the component.
- 3. CONCEPTUAL CONNECTION By how much would the per-unit relevant fixed cost have to decrease before Zion would be indifferent (i.e., incur the same cost) between “making” versus “purchasing” the component? Show and briefly explain your calculations.
1.
Describe whether the operating income will increase or decrease if the component is purchased.
Make-or-Buy Decisions:
The common problem for the managers is to make a decision about whether to purchase a product from the supplier or to produce a specific product. The decisions which involve the choice between external production and internal production are known as make-or-buy decisions.
The following table represents the impact of purchases on the operating income:
| Costs | Alternatives | Differential cost to make ($) | |
| Make ($) | Buy ($) | ||
| Purchase cost | Â | 25 | 25 |
| Direct materials | Â | (12) | (12) |
| Direct labor | Â | (8.25) | (8.25) |
| Variable overhead | Â | (4.5) | (4.5) |
| Increase in operating income per unit | Â | 0... | |
2.
Describe the impact on the final decision of increasing or decreasing the 75% figure.
3.
Calculate the amount of decrease in per unit fixed overhead so that the cost to purchase and the cost to make become equal.
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