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. 8,000 units of CISCO were produced in the Machining Department.
2. Variable manufacturing costs applicable to the production of each CISCO unit were:
    direct materials $4.80, direct labor $4.30, indirect labor $0.43, utilities $0.40.
3. Fixed manufacturing costs applicable to the production of CISCO were:

Cost Item		Direct		Allocated
Depreciation		$2,100		$900
Property taxes		500		200
Insurance		900		600
		$3,500		$1,700

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 8,000 CISCO units from a supplier is $80,000.
5. If CISCO units are purchased, freight and inspection costs would be $0.35 per unit, and receiving costs totaling $1,300 per year would be incurred by the Machining Department.

(d)

What nonfinancial factors should management consider in making its decision?

Answer 1

Answer 1:

Given that:

All variable manufacturing and direct fixed costs will be eliminated if CISCO is purchased.

Incremental cost analysis:

So, if CISCO is purchased, total cost saved is as follows:

If CISCO is purchased, cost incurred are as follows:

So, if CISCO is purchased:

Net Financial advantage (disadvantage) = Incremantal saving - Incremantal cost = 82940 - 84100 = ($1,160).

So purchase of CISCO results in financial disadvantage of $1160.

Company shoud not purchase CISCO. It is better that company manufactures it.

Answer 2:

Nonfinancial factors management should consider in making its decision are:

1. Loss of control and flexibility as the company would be dependent on supplier. The supplier must be reliable so that production does not suffer for want of regular supply CISCO.

2. Quality issues: If company purchases CISCO from outside, it must evaluate the quality of CISCO it purchases. It would be dependent on the supplier for the same. Any quality issue with the part may result in rejection of company's finished product. This may impact revenue and also may impact its image/brand and may result in loss of potential customers.