Question

OmniSport Inc. is a wholesale distributor supplying a wide range of moderately priced sporting equipment to large chain stores. OmniSport has an enviable reputation for quality of its products. In fact, the demand for its products is so great that at times OmniSport cannot satisfy the demand and must delay or refuse some orders, in order to maintain its production quality. Additionally, OmniSport purchases some of its products from outside suppliers in order to meet the demand. These suppliers are carefully chosen so that their products maintain the quality image that OmniSport has attained. About 60 percent of OmniSport's products are purchased from other companies while the remainder of the products are manufactured by OmniSport. The company has a Plastics Department that is currently manufacturing the boot for in-line skates. OmniSport is able to manufacture and sell 5,000 pairs of skates annually, making full use of its machine capacity at available workstations. Presented below are the selling price and costs associated with OmniSport's skates.

Selling price per pair of skates $98

Costs per pair Molded plastic $8

Other direct materials 12

Machine time ($16/hr.) 24

Manufacturing overhead 18

Selling and admin. cost 15 77

Profit per pair $21

Because OmniSport believes it could sell 8,000 pairs of skates annually if it had sufficient manufacturing capacity, the company has looked into the possibility of purchasing the skates for distribution. Colcott Inc., a steady supplier of quality products, would be able to provide 6.000 pairs of skates per year at a price of $75 per pair delivered to OmniSport's facility. Jack Petrone, OmniSport's product manager, has suggested that the company could make better use of its Plastics Department by manufacturing snowboard bindings. To support his position, Petrone has a market study that indicates an expanding market for snowboards and a need for additional suppliers. Petrone believes that OmniSport could expect to sell 12,000 snowboard bindings annually at a price of $60 per binding. Petrone's estimate of the costs to manufacture the bindings is presented below.

Selling price per snowboard binding $60

Costs per binding Molded plastic $16

Other direct materials 4 Machine time ($16/hr.) 8

Manufacturing overhead 6

Selling and admin. cost 14 48

Profit per binding $12

Other information pertinent to OmniSport's operations is presented below. An allocated $6 fixed overhead cost per unit is included in the selling and administrative cost for all of the purchased and manufactured products. Total fixed and variable selling and administrative costs for the purchased skates would be $10 per pair. In the Plastics Department, OmniSport uses machine hours as the application base for manufacturing overhead. Included in the manufacturing overhead for the current year is $30,000 of fixed, factory-wide manufacturing overhead that has been allocated to the Plastics Department.

REQUIRED: To maximize OmniSport Inc.'s profitability, recommend which product or products should be manufactured and/or purchased. Prepare an analysis based on the data presented that will show the associated financial impact. Support your answer with appropriate calculations and strategic considerations

Answer 1

Here we have two alternatives to analyse and discuss the profitability arising from each of them:-

Alternative 1. : Use plastic department to manufacture 5000 skates and buy 3000 pair of skates from Colcott inc

Alternative 2 : Use Plastic department to manufacture 12000 snowboard bindings and buy 6000 pair of skates from Colcott inc We will identify Contribution and Profit from both of these alternative

Analysis of Alternative 1
Head	Plastic Dept	Colcott inc	Total	calculation
Selling price of skates	$98	$98	$7,84,000	98*8000
Less : Variable costs
purchase cost		-$75	-$2,25,000	75*3000
Molding	-$8		-$40,000	5000unit * Variable cost per unit
Other direct material	-$12		-$60,000	5000unit * Variable cost per unit
Machine exp	-$24		-$1,20,000	5000unit * Variable cost per unit
Variable manufacturing overhead	-$2		-$10,000	5000unit * Variable cost per unit
Variable Selling and administration cost	-$3.85		-$19,250	5000unit * Variable cost per unit
Contribution	$48	$23	$3,09,750	Sales less variable cost

Segregation of Fixed and Variable Manufacturing overheads :-

Allocation base for fixed manufacturing overheads used is Machine hours

We know that full capacity of Plastics department is 5000 skates and Machine time taken = $24/$16 = 1.5 hours therefore, total machine hours for the base = 1.5* 5000 = 7500 hours

Here, $30,000 is included in the manufacturing overhead is fixed in nature so, per unit of skates it can be presented as = $30000/7500 = $4 per unit

So, Variable Manufacturing overhead fro plastics department is = 6-4 = $2 per unit

Segregation of Fixed an variable selling and administration overheads

It has been given in question that allocated Fixed selling and administration to Purchased as well as manufactured skates is $6 therefore we can imply that total fixed selling and administrative overheads are allocation rate multiplied by units sold i.e. 8000 = 6*8000 = $48000. In the above information, Selling and administrative expense per unit for 5000 skates is given as $15.77 or Total Expense = 15.77* 5000 = $78850. Therefore the variable selling and administration overhead for plastics department is 78850- 48000 = 30850. Per unit = 30850/8000 = $3.85 per unit of skates

Analysis of Alternative 2

Head	Plastic Dept12000 snowboard bindings	Colcott inc 6000 skates	Total	calculation
Selling price	$60	$98	$13,08,000	12000*60 + 6000*98
Less : Variable costs
purchase cost		-$75	-$4,50,000	6000*75
Molding	-$10		-$1,20,000	12000 * Variable costs per unit
Other direct material	-$4		-$48,000	12000 * Variable costs per unit
Machine exp	-$8		-$96,000	12000 * Variable costs per unit
Variable manufacturing overhead	-$1		-$12,000	12000 * Variable costs per unit
Variable Selling and administration cost	-$10.48	-$10	-$1,85,760	12000*10.48 + 6000*10
Contribution	$27	$13	$3,96,240	Sales less variable cost

Segregation of Fixed and Variable Manufacturing overheads :-

Allocation base for fixed manufacturing overheads used is Machine hours

We know that full capacity of Plastics department is 12000 bindings and Machine time taken = $8/$16 = 0.5 hours therefore, total machine hours for the base = 0.5*12000 = 6000 hours

Here, $30,000 is included in the manufacturing overhead is fixed in nature so, per unit of bindings it can be presented as = $30000/6000 = $5 per unit

So, Variable Manufacturing overhead fro plastics department for binding manufacturing is is = 6-5 = $1 per unit

Segregation of Fixed an variable selling and administration overheads

It has been given in question that allocated Fixed selling and administration to Purchased as well as manufactured skates is $6 therefore we can imply that total fixed selling and administrative overheads are allocation rate multiplied by units sold i.e. 8000 = 6*8000 = $48000. In the above information, Selling and administrative expense per unit for 12000 bindings skates is given as $14.48 or Total Expense = 14.48* 12000 = $173760. Therefore the variable selling and administration overhead for plastics department is 173760- 48000 = 125760. Per unit = 125760/12000 = $10.48 per unit of binding.

We must go for Alternative 2 i.e. Manufacture 12000 snowboard bindings using Plastic department and purchase 6000 skates from Colcotts Inc to sell in market which already has a demand of 8000 skates from Omnisports. If we take a look at contribution in bottom rightmost column of both the analysis table showing contribution, it is evident that contribution can be maximized by $86490 by redirecting plastics department as per the product manager suggestion. We have not considered any fixed costs here because in decision making these costs are indifferent costs and will be incurred by Omnisports anyway.  Redirecting plastics department is not incurring any additional fixed cost as per question.