Question

Cleaning Equipment Specialists Ltd (CES) manufacture cleaning equipment for household and industrial use. They have received a bid from a supplier to provide motors for their household vacuum cleaner product line. The bid is to supply 10,000 motors at a price of $85 each. CES currently manufacture the motors in-house.

The management accountant of CES has estimated the current costs of producing one motor as follows:

Direct Materials        $42

Direct Labour            18

Variable Overhead   20

Fixed Overhead         66

                                 $146

(a) Based on the above information should CES produce the motor in-house or purchase from the supplier?

The CEO of CES has asked the management accountant to investigate whether any decreases in costs would be possible if they purchase the motor from the supplier. The accountant has determined that the company would be able to save costs on setups as two less setups would be required in the manufacture of the vacuum cleaners. Total spending would be reduced by $16,650 per setup. The material handling division would be able to reduce staff costs by laying off one staff member at a saving of $33,300 and one quality control inspector would also be able to be laid off saving CES $46,600. It is also determined that Engineering work would be reduced by 400 hours at $15 per hour. However, even though the work decreases by 400 hours the engineer assigned to making the motors also spends time on other products.

(b) Given the additional information from the management accountant’s investigation is your answer the same as in (a) above? Repeat your analysis showing all workings and state any assumptions you have made.

(c) Identify and discuss any other factors (i.e. qualitative factors) or strategic implications that may affect CES’s decision on whether to outsource the production of the vacuum cleaner motors.

Answer 1

(a)

Particulars	In-house Production	Outside Acquisition
Relevant costs	Direct Materials- $42 Direct Labour- $18 Variable OH-   $20 Total $80	Cost of purchase- $85

Conclusion- Since cost per motor for inhouse production is less than outsiders quotation, In-house production is better.
Note- Fixed OH is absorbed costs hence irrelevant for decision making.

(b)

Particulars	In-house Production	Outside Acquisition
Relevant costs per motor	Direct Materials- $42 Direct Labour- $18 Variable OH-      $20 Total $80	Cost of purchase- $85
Total relevant costs for 10000 motors	$800000	$850000
Less- Relevant cost savings	Nil	Set up costs -                 $33300 (2*$16650) Staff Lay off    -Material handling $33300    -Quality Inspection   $46600 Total $113200
Net Relevant costs for 10000 motors	$800000	$736800
Net Relevant cost per motor	$80	$73.68

Conclusion- Since cost per motor on outside purchase is less than in-house production, Outsiders acquisition is better.
Note- Salary for engineering work is committed, hence irrelevant for decision making.

(c) Other qualitative factors that may affect CES's decision are as follows-
- Availability of all factor inputs.
- Outside purchases availability may be occasional.
- Possibility of non completion of in-house production within the stipulated time.
- Effect of outsider acquisition on other business revenues.
- Effect of Lay off on other workers