Question

A Company manufactures control panels for burglar alarms, a very profitable product. Every product comes with a one year warranty offering free repairs if any faults arise in this period.

It currently produces and sells 80,000 units per annum, with production of them restricted by the short supply of labour.   Each control panel includes two main components – one key pad and one display screen. At present, the Company manufactures both of these components in-house. However, the company is currently considering outsourcing the production of keypads and/or display screens. A newly established company is keen to secure a place in the market and has offered to supply the keypads for the equivalent of $4.10 per unit and the display screens for the equivalent of $4.30 per unit. This price has been guaranteed for two years.

The current total annual costs of producing the keypads and the display screens are:

                                                                                                                Keypads               Display screens

Production                                                                                   80,000 units               80,000 units

                                                                                                                    $’000                      $’000

Direct materials                                                                                      160                          116

Direct labour                                                                                              40                           60

Fuel and power costs                                                                              64                           88

Machine costs                                                                                   26                           30

Depreciation and insurance costs                                                 84                          96

Total annual production costs                                                      374                        390

Notes:

1. Materials costs for keypads are expected to increase by 5% in six months’ time; materials costs for display screens are only expected to increase by 2%, but with immediate effect.
2. Direct labour costs are purely variable and not expected to change over the next year.
3. Fuel and power costs include an apportionment of the general factory overhead for fuel and power as well as the costs of fuel and power directly used for the production of keypads and display screens. The general apportionment included is calculated using 50% of the direct labour cost for each component and would be incurred irrespective of whether the components are manufactured in-house or not.
4. Machine costs are semi-variable; the variable element relates t set up costs, which are based upon the number of batches made. The keypads’ machine has fixed costs $4,000 per annum and the display screens’ machine has fixed costs of $6,000 per annum. Whilst both components are currently made in batches of 500, this would need to change, with immediate effect, to batches of 400.
5. 60% of depreciation and insurance costs relate to an apportionment of the general factory depreciation and insurance costs; the remaining 40% is specific to the manufacture of keypads and display screens.

Required

Advise the Company whether it should continue to manufacture the keypads and display screens in-house of whether it should outsource their manufacture to the supplier, assuming it continues to adopt a policy to limit manufacture and sales to 80,000 control panels in the coming year.    Please enter in format to in order for me to copy and paste.

Answer 1

Existing
		Keypads		Display screen
		Rate per Unit	Total	Rate per Unit	Total
Direct Material		$             2.00	$160,000.00	$             1.45	$116,000.00
Direct Labor		$             0.50	$ 40,000.00	$             0.75	$ 60,000.00
Fuel Power and Cost:
Variable		$             0.55	$ 44,000.00	$             0.73	$ 58,000.00
General Aportionment		$    20,000.00	$ 20,000.00	$    30,000.00	$ 30,000.00
Machine Cost:
Variable		$             0.28	$ 22,000.00	$             0.30	$ 24,000.00
Fixed		$      4,000.00	$    4,000.00	$      6,000.00	$    6,000.00
Depreication and Insurance:
General		$    50,400.00	$ 50,400.00	$    57,600.00	$ 57,600.00
Specific		$    33,600.00	$ 33,600.00	$    38,400.00	$ 38,400.00
No of Batches	80000units/500	160	Batches
No of Batches (Revised)	80000units/400	200	Batches

New Scenario
	Keypads		Display screen		Relevance
	Rate per Unit	Total	Rate per Unit	Total
Direct Material	2 for first six months,2.5 for next six months	$ 180,000	$                  1.48	$ 118,320	Relevant
Direct Labor	$                          0.50	$   40,000	$                  0.75	$   60,000	Relevant
Fuel Power and Cost:
Variable	$                          0.55	$   44,000	$                  0.73	$   58,000	Relevant
General Aportionment		$   20,000		$   30,000	Irrelevant
Machine Cost:
Variable	22000/160*200	$   27,500	24000/160*200	$   30,000	Relevant
Fixed		$     4,000		$     6,000	Relevant
Depreication and Insurance:
General		$   50,400		$   57,600	Irrelevant
Specific		$   33,600		$   38,400	Relevant
Total Relevant Cost		$ 329,100		$ 310,720
No of Units		80,000.00		80,000.00
Per unit Cost to Manufacture		$       4.11		$       3.88
Per Unit cost to Buys		$       4.10		$       4.30
Buy/Make		Buy		Make