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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773

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BuyFindarrow_forward

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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Make or Buy, Qualitative Considerations

Hetrick Dentistry Services operates in a large metropolitan area. Currently, Hetrick has its own dental laboratory to produce porcelain and gold crowns. The unit costs to produce the crowns are as follows:

Chapter 8, Problem 57P, Make or Buy, Qualitative Considerations Hetrick Dentistry Services operates in a large metropolitan , example  1

Fixed overhead is detailed as follows:

Chapter 8, Problem 57P, Make or Buy, Qualitative Considerations Hetrick Dentistry Services operates in a large metropolitan , example  2

Overhead is applied on the basis of direct labor hours. These rates were computed by using 5,500 direct labor hours.

A local dental laboratory has offered to supply Hetrick all the crowns it needs. Its price is $125 for porcelain crowns and $150 for gold crowns; however, the offer is conditional on supplying both types of crowns—it will not supply just one type for the price indicated. If the offer is accepted, the equipment used by Hetrick’s laboratory would be scrapped (it is old and has no market value), and the lab facility would be closed. Hetrick uses 2,000 porcelain crowns and 600 gold crowns per year.

Required:

  1. 1. CONCEPTUAL CONNECTION Should Hetrick continue to make its own crowns, or should they be purchased from the external supplier? What is the dollar effect of purchasing?
  2. 2. CONCEPTUAL CONNECTION What qualitative factors should Hetrick consider in making this decision?
  3. 3. CONCEPTUAL CONNECTION Suppose that the lab facility is owned rather than rented and that the $32,000 is depreciation rather than rent. What effect does this have on the analysis in Requirement 1?
  4. 4. CONCEPTUAL CONNECTION Refer to the original data. Assume that the volume of crowns used is 4,200 porcelain and 600 gold. Should Hetrick make or buy the crowns? Explain the outcome.

1.

To determine

Describe whether H should produce crown or purchase from the supplier. Also, calculate the dollar effect of the purchase.

Explanation

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 most cost-effective alternative:

CostsAlternativesDifferential cost to make ($)
Make ($)Buy ($)
Raw materials1218,000 218,000
Direct labor270,200 70,200
Variable overhead320,800 20,800
Fixed overhead458,000 58,000
Purchase cost5 340,000(340,000)
Total relevant cost367,000340,00027,000

Table (1)

If the company purchases the crown then it will cost $340,000 which is cheaper than the other alternative by $27,000.

Working Notes:

1. Calculation of raw materials:

Raw materials=(Number of porcelain crowns×Unit cost)+(Number of golden crowns×Unit cost)=(2,000×70)+($600×130)=$140,000+$78,000=$218,000

Hence, the amount of raw materials is $218,000.

2. Calculation of direct labor:

Direct labor=(Number of porcelain crowns+Number of golden crowns)×Unit cost of direct labor=(2,000+600)×$27=2,600×$27=$70,200

Hence, the amount of direct labor is $70,200

2.

To determine

Describe the qualitative factors that should be considered by H while making a decision.

3.

To determine

Describe the effect on the decision of make-or-buy when the lab facility is owned rather than rented and the amount of $32,000 is considered as depreciation.

4.

To determine

Describe whether H should produce its crown or purchase from the supplier if the number of porcelain crowns is 4,200.

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