BUS 5110 Make or Buy Differential Analyses of Vacuum Manufacturer PDF

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5110 Managerial Accounting...

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UNIVERSITY OF THE PEOPLE

Make or Buy Differential Analyses of Vacuum Manufacturer

BUS 5110: Managerial Accounting

Dr. Zelealem Tadesse (Instructor) 02/24/2021

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Make or Buy Differential Analyses of Vacuum Manufacturer Introduction The purpose of this paper is to present the make or buy differential analyses based on the vacuum engine manufacturer case study. In the make-or-buy decision-makers would select the alternative with the lowest cost and differential analysis requires the identification of all revenues and costs that differ from one alternative to another (Heisinger & Hoyle, n.d.). The first approach is converting costs on a yearly basis because the givens are mixed values. All costs and revenue are identified based on the case study as follows.

Variable production costs

Fixed production costs (Fixed factory overhead)

Costs to Make Vacuum

Costs

Direct materials

$75,000 x 12= $900,000

Direct labor

$100,000 x 12=$1,200,000

Variable factory overhead

$7.50 x 50,000 = $375,000

Executive salaries

$1, 200,000 x 150%= $1,800,000

Rent

Costs to Buy Vacuum

Costs

Vacuum from supplier

$60 x 50,000 = $3,000,000

Executive salaries

$1,800,000 x 75% = $1,350,000

Rent

Depreciation

Depreciation

Taxes

Taxes

Table 1: Specific costs determination for vacuum manufacturer. All the costs specified on table 1 are differential, that means all are relevant costs. Sales ($150 per unit x 50,000 unit =7,500,000) is not included here in the table since it is not differential, it is considered as irrelevant. Variable costs are calculated by multiplying by 12 months (direct material per month is 75,000 x 12 months = $900,000 annual cost and direct labor per month is 100,000 x 12 months = 1,200,000 annual cost). The variable factory overhead is $7.50 per unit x 50,000 units per year =$375,000. The fixed factory overhead needs some further calculation of

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unit labor cost, we already got $1,200,00 per year labor cost and 50,000 units per year, therefore, 1,200,000 ÷ 50,000 units = $24 labor cost per unit, then 150% of $24 results 1.5 x 24 = $36. Per Unit Variable production costs Direct materials Direct labor Variable factory overhead Fixed production costs Fixed factory overhead Total production costs

Total Annual Costs per 50,000 Units

$ $ $

18.00 24.00 7.50

$ $ $

$ $

36.00 85.50

$ $

900,000 1,200,000 375,000 1,800,000 4,275,000

Table 2: The total production costs when making the vacuum internally. Since the Vacuum Manufacturer is producing 50,000 units per year, the product cost per unit is ($85.50 = $4,275,000 ÷ 50,000). The next step is preparing the differential analyses based on the two alternatives of make or buy. Therefore, we need to identify costs and revenue that incur during the buying process, the sales remain the same, buying cost considered as the direct material cost will be $60 per unit x 50,000 = 3,000,000, the direct labor and the variable factory overhead costs will be avoidable costs which considered as the differential, the continued part of the fixed factory overhead (executive salaries, rent, depreciation, and taxes) will be 75% x $1,800,000 = $1,350,000. The differential amount is presented in table 3.

Alternative 1: Make

Alternative 2: Buy

Differential Amount

Variable production costs Direct materials $ 900,000 $ 3,000,000 $ (2,100,000) Direct labor $ 1,200,000 $ $ 1,200,000 Variable factory $ overhead $ 375,000 $ 375,000 Fixed production costs Fixed factory overhead $ 1,800,000 $ 1,350,000 $ 450,000 Total production costs $ 4,275,000 $ 4,350,000 $ (75,000) Table 3: Make-or-buy differential analyses of vacuum manufacturer.

Alternativ e 1 is Lower Higher Higher Higher Lower

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Table 3 clearly shows that the buying alternative has a negative $75,000 impact on the overall production costs, which will be reflected on the profit of the company at the end of the day. Thus, management now has a clear understanding of being misled by $85.5 per unit in-house production cost and $60 per unit of cost during outsourcing, which simply shows $25.5 per unit benefit, realizing the fixed overhead cost is very important. The gain and loss of buying the product per the differential analyses we have seen in the above have been summarized in table 4. Outsourcing Result of Vacuum

Cost increase to buy from outside Direct materials cost savings Direct labor cost savings Variable factory overhead cost savings Fixed factory overhead cost savings Cost increase from outsourcing

$ (3,000,000) $ 900,000 $ 1,200,000 $ 375,000 $ 450,000 $ (75,000)

Table 4: The result of buying the product. Conclusion In general, the company will benefit from making rather than buying. The decision-makers now have alternatives to make their decision. The fixed factory overhead (executive salaries, rent, depreciation, and taxes) savings of 25% are considered in the analysis as well. Based on this analysis I suggest the manufacturer proceed with making the vacuum. But managers may consider some opportunity costs, like machinery and equipment market values and maintenance costs, before making their final decision. The company may also consider existing idle production capacity, better quality control, or proprietary technology protection as well as concerns regarding the reliability of the supplier, especially if the product is critical to the normal business operations of the company (Kenton, 2021, February 8). With these and other customerrelated factors, the managers may decide accordingly.

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References Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for Managers. https://2012books.lardbucket.org/books/accounting-for-managers/index.html Kenton, W. (2021, February 8). Make-or-buy decision. https://www.investopedia.com/terms/m/make-or-buy-decision.asp...