Slide 1
Coleman Company owns a machine that produces a component for the
products the company makes and sells. The company uses 1,800 units
of this component in production each year. The costs of making one
unit of this component areDirect material$ 7Variable manufacturing
overhead $ 6Direct labor$ 4Fixed manufacturing overhead$ 5
The fixed overhead costs are unavoidable, and the unit cost is
based on the present annual usage of 1,800 units of the component.
An outside supplier has offered to sell Coleman this component for
$18 per unit and can supply all the units it needs.
A. If Coleman buys the component from the outside supplier
instead of making it, how much will net income change? Should
Coleman make or buy the component? Use the incremental approach to
justify your answer.B. Suppose Coleman could rent the machine to
another company for $5,000 per year. How would your response change
to part A? Use the incremental approach to justify your answer.A.
Since net income decreases, Coleman should continue making the
component.Variable cost = $7 + $6 + $4 = $17Incremental cost
savings from not making component (1,800 x $17)=$30,600Incremental
cost of buying component (1,800 x $18)= (32,400)Incremental
decrease in net income due to buying component= $(1,800)
B. Since net income increases, the company should choose to buy
the components.Incremental cost savings from not making component
(1,800 x $17)= $30,600Incremental Annual rent from machine=
$5,000Incremental Cost of buying component (1,800 x $18)=
(32,400)Incremental Increase in net income due to buying component=
$3,200
Sabab, Inc. produces 4 different qualities of cable for
broadband internet hookups. Sabab currently produces 800,000 yards
of economy cable each month. The costs of making each yard is $0.12
for direct materials, $0.05 for variable manufacturing overhead,
$0.03 for variable administrative overhead, $0.06 for direct labor,
and $0.12 for fixed manufacturing overhead. Overhead is allocated
based on direct labor hours. An outside supplier has offered to
sell Sabab economy cable for $0.28 per yard, and can supply all it
needs. The company determined that 15% of the fixed overhead is
avoidable if the company discontinues production of the economy
cable. In addition, the company could lease the machine used to
make the economy cable to another company for $8,000 annually.
Determine if Sabab shouldoutsource the component.Incremental
cost to buy($224,000)Incremental variable cost savings Direct
materials+96,000Direct labor+48,000Variable manufacturing
overhead+40,000Variable administrative overhead+24,000Incremental
fixed overhead savings+14,400Incremental lease revenue is
bought+8,000/12=666.67----------------------------------------------------------------------------------Incremental
increase in profit if bought($933.33)
ShouldSababoutsource?No.
Smith Company manufactures widgets. Newman Company has
approached Smith with a proposal to sell the company one of the
components used to make widgets at a price of $100,000 for 50,000
units. Smith is currently making these components in its own
factory. The following costs are associated with this part of the
process when 50,000 units are produced:Direct material$44,000Direct
labor$20,000MOH$60,000The manufacturing overhead consists of
$32,000 of costs that will be eliminated if the components are no
longer produced by Smith. The remaining manufacturing overhead will
continue whether or not Smith makes the components. Answer the
following questions from Smith's point of view.Should Smith make or
buy the components for the widgets?Continue to make them because
the incremental cost of buying from Newman is $4,000.Incremental
analysis:Incremental cost to buy ($100,000)Incremental cost savings
to make: DM + $44,000 DL + $20,000 MOH + $32,000
Incremental cost to buy ($4,000)
