Question

The management of Shatner Manufacturing Company is trying to decide whether to continue manufacturing a part or to buy it from an outside supplier. The part, called CISCO, is a component of the company’s finished product.

The following information was collected from the accounting records and production data for the year ending December 31, 2020.

1. 8,100 units of CISCO were produced in the Machining Department.
2. Variable manufacturing costs applicable to the production of each CISCO unit were:
    direct materials $4.65, direct labor $4.46, indirect labor $0.45, utilities $0.38.
3. Fixed manufacturing costs applicable to the production of CISCO were:

Cost Item		Direct		Allocated
Depreciation		$2,000		$870
Property taxes		480		350
Insurance		860		630
		$3,340		$1,850

All variable manufacturing and direct fixed costs will be eliminated if CISCO is purchased. Allocated costs will not be eliminated if CISCO is purchased. So if CISCO is purchased, the fixed manufacturing costs allocated to CISCO will have to be absorbed by other production departments.

4. The lowest quotation for 8,100 CISCO units from a supplier is $80,707.
5. If CISCO units are purchased, freight and inspection costs would be $0.37 per unit, and receiving costs totaling $1,310 per year would be incurred by the Machining Department.

(a) Prepare an incremental analysis for CISCO. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

		Make CISCO		Buy CISCO		Net Income Increase (Decrease)
Direct material		$enter direct material in dollars		$enter direct material in dollars		$enter direct material in dollars
Direct labor		enter direct labor in dollars		enter direct labor in dollars		enter direct labor in dollars
Indirect labor		enter indirect labor in dollars		enter indirect labor in dollars		enter indirect labor in dollars
Utilities		enter utilities in dollars		enter utilities in dollars		enter utilities in dollars
Depreciation		enter depreciation in dollars		enter depreciation in dollars		enter depreciation in dollars
Property taxes		enter property taxes in dollars		enter property taxes in dollars		enter property taxes in dollars
Insurance		enter insurance in dollars		enter insurance in dollars		enter insurance in dollars
Purchase price		enter the purchase price in dollars		enter the purchase price in dollars		enter the purchase price in dollars
Freight and inspection		enter freight and inspection in dollars		enter freight and inspection in dollars		enter freight and inspection in dollars
Receiving costs		enter receiving costs in dollars		enter receiving costs in dollars		enter receiving costs in dollars
Total annual cost		$enter total annual cost in dollars		$enter total annual cost in dollars		$enter total annual cost in dollars

(b) Based on your analysis, what decision should management make?

The company should select between make and buy                                                          buy CISCOmake CISCO.

(c) Would the decision be different if Shatner Company has the opportunity to produce $3,000 of net income with the facilities currently being used to manufacture CISCO?

Answer 1

Part a)

The Incremental Analysis for CISCO is as below:

	Make	Buy	Net Income Increase/Decrease
Direct Material (8,100*4.65)	37,665	0	37,665
Direct Labor (8,100*4.46)	36,126	0	36,126
Indirect Labor (8,100*0.45)	3,645	0	3,645
Utilities (8,100*0.38)	3,078	0	3,078
Depreciation (2,000+870)	2,870	870	2,000
Property Taxes (480+ 350)	830	350	480
Insurance (860+630)	1,490	630	860
Purchase Price	0	80,707	-80,707
Freight and Inspection (8,100*0.37)	0	2,997	-2,997
Receiving Costs	0	1,310	-1,310
Total Annual Cost	$85,704	$86,864	-$1,160

Net Income decreases by $1,160

Important information:

1) Allocated fixed costs will also be incurred at the time of buying the product, hence, included in the total annual costs.

2) In case of make, total fixed costs would include both direct and allocated.

_________________________

Part b)

It is advisable that the company should continue to make the product because if it decides to purchase it from outside, it would result in a decrease in net income by $1,160.

_________________________

Part c)

If there is an increase in income by $3,000 the company should buy the product. It is so because after adjusting the decrease in income resulting from purchase, the company's net income would still increase by $1,840 ($3,000 - $1,160). This couldn't have been possible if the company had continued to use the facilities used to manufacture CISCO.

Net Income Increase = Additional Income - Decrease in Income from Buying = $3,000 - $1,160 = $1,840