Question

1. Scopus Team Ltd is a treadmill specialist currently reviewing its product lines, accessories and the prospect of outsourcing few of them. As a part of this process, the CEO of the firm has appointed you as a consultant and you have chosen their treadmill product line for the possibility of outsourcing.

The company sells 22,000 of treadmills annually of two models (ZR & SQ) and their factories are located in Kent and Hull respectively. The Hull Division is their flagship unit that showcases the company’s investment in the Clean & Environment-friendly Fuel source as the division is completely run by bio-energy. The accountant of the company has provided the following information relating to the production and distribution costs of one unit of the various models of the treadmill:

	ZR series	SQ series
Annual sales (in units)	10,000	12,000
Sales price per unit	£650	£750
Direct materials per unit	£80	£100
Direct labour per unit	£50	£40
Variable manufacturing overhead per unit	£25	£45
Fixed manufacturing overhead per unit	£40	£75
Variable selling and administrative overhead per unit	£15	£20
Fixed selling and administrative overhead per unit	£30	£20

An external supplier has offered to supply the same quality of ZR & SQ for £150 and £200 respectively. However, if the company accepts the offer, the following information should be taken into consideration:

1. 85% of material costs and 80% of labour costs will be saved if external supplier’s offers are accepted. The company would be able to save all variable manufacturing overhead
2. More warehouse spaces will be required in Kent for £15,000 per month in order to stock the products delivered from the external supplier; however, Hull Division has spare storage capacity for ZR series if required.
3. All of the fixed selling and administrative costs and 35% of the fixed manufacturing overhead costs are allocated costs (common costs).
4. Production supervisor’s job will be terminated. Her salary represents 25% of the fixed manufacturing cost. The rest of the fixed manufacturing overhead costs (i.e. excluding allocated costs and production supervisor’s salary) is the depreciation of machines. The external supplier has promised to pay 75% of the resale value of the machines if their offer is accepted.
5. Since customers’ order and delivery of the treadmills to customers will be responsibility of the Scopus, the company will continue paying 80% of the variable selling and administrative costs.

Required:

1. As a management consultant, prepare a report for the CEO that may help her to resolve the issue. In your report, you should apply an appropriate management accounting technique, concept(s) and/or theory. You must show detailed computation and elaborate concepts and theory that are important to manager since she does not have any background in management accounting.
2. Identify irrelevant costs and/or revenues in the above calculation and explain why they are irrelevant.                   
3. What would be the maximum price acceptable to Scopus to justify outsourcing their production from the external supplier? Show your computation
4. Would you change your decision if the external supplier delivers directly to customer and no additional storage capacity required for the Kent Division? Show necessary computation that support your argument.
5. Critically evaluate what additional qualitative factors the company should consider in deciding whether to make or buy the product from outside suppliers.
6. What additional information you might seek from the company accountant to make a better decision? Discuss your information requirements and their importance in this context.

Answer 1

		Allocated Cost will be incurred irrespective of decision. Hence, Not Relevant
		Depreciation of machine is not relevant for this analysis
		Relevant fixed manufacturing cost	25%	(
			INHOUSE PRODUCTION COST	COST IF OUTSOURCED
			ZR	SQ	Total	ZR	SQ	Total
	a	Units	10000	12000		10000	12000
	b	Purchase Cost per unit				150	200
	c=a*b	Total Purchase cost				1,500,000	2,400,000	3,900,000
	d	Direct Material per unit	80	100		12	15
	e=a*d	Total Materials cost	800,000	1,200,000	2,000,000	120,000	180,000	300,000
	f	Direct Labor per unit	50	40		10	8
	g=a*f	Total Direct labor cost	500,000	480,000	980,000	100,000	96,000	196,000
	h	Variable manufacturing overhead per unit	25	45
	i=a*h	Total Variable Manufacturing Overhead	250,000	540,000	790,000
	j	Fixed manufacturing overhead per unit(25%)	10	18.75
	k=a*j	Total Fixed Manufacturing Overhead	100,000	225,000	325,000
	l	Variable Selling &Admin Overhead per unit	15	20		12	16
	m=a*l	Total Variable Selling and admin Overhead	150,000	240,000	390,000	120,000	192,000	312,000
	n	Warehouse cost					180,000	180,000
	X=c+e+g+i+k+m	TOTAL COST	1,800,000	2,685,000	4,485,000	1,840,000	3,048,000	4,888,000
		Total Cost for outsourcing is higher
		Hence it is not recommended to outsource
		Maximum Price acceptable	ZR	SQ	Total
	o	Total maximum cost allowed	1,800,000	2,685,000	4,485,000
	p	Total Cost with the offer	1,840,000	3,048,000	4,888,000
	q=p-o	Reduction in cost needed	40,000	363,000	403,000
	Y=q/a	Reduction Per unit in price needed	4	30
	Z=b-Y	Maximum Price acceptable	146	170
		IF NO ADDITIONAL STORAGE CAPACITY IS NEEDED
		Total Cost with the offer	1,840,000	2,868,000	4,708,000	(3048000-1800000)
		Still the Total cost with outsourcing will be higher
		Hence , not acceptable
		Qualitative factors
		Quality of supply
		Reliability of supply