Management Accounting Answer [PDF]

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QUESTION: P7 – 2A

The management of Shatner Manufacturing Company is trying to decide whether to continue manufacturing a part or to buy it from an outsider 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, 2017. 1. 8,000 units of CISCO were produced in the Machining Department. 2. Variable manufacturing cost applicable to the production of each CISCO unit were: direct materials $4.80, direct labour$4.30 indirect labour $0.43, utilities $0.40

sh is ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m

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 cost will be eliminated if CISCO is purchased. Allocated costs 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 totalling $1,300 per year would be incurred by the Machining Department.

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Instructions

a) Prepare an incremental analysis for CISCO. Your analysis should have columns for (1) Make CISCO, (2) Buy CICCO, and (3) Net income Increase / (Decrease). b) Based on your analysis, what decision should management make?

c) Would the decision be different if Shatner Company has the opportunity to produce $3,000 of net income with the facilities currently being used to manufacture CISCO? Show computations. d) What non-financial factors should management consider in making its decision?

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ANSWERS

a) SHATNER MANUFACTURING COMPANY INCREMENTAL ANALYSIS Make CISCO

Buy CISCO

Net Income Increase / (Decrease)

Direct Material

38,400

38,400

Direct Labour

34,400

34,400

Indirect Labour

3,440

3,440

Utilities

3,200

3,200

Depreciation

3,000

900

2,100

700

200

500

sh is ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m

Property taxes Insurance

1,500

600

900

80,000

(80,000)

Freight and Inspection

2,800

(2,800)

Receiving Cost

1,300

(1,300)

85,800

(1,160)

Purchase Price

Total Annual Cost

84,640

Computations:

Direct Material Direct Labour Indirect Labour Utilities Freight and Inspection

4.8 x 8,000 = 38,400 4.3 x 8,000 = 34,400 0.43 x 8,000 = 3,440 0.4 x 8,000 = 3,000 0.35 x 8,000 = 2,800

Fixed manufacturing costs applicable to the production of CISCO:

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Depreciation Property taxes Insurance

2,100 (direct) + 900 (allocated) = 3,000 500 (direct) + 200 (allocated) = 700 900 (direct) + 600 (allocated) = 1,500

*Allocated costs will have to be absorbed by other production department.

b)

The management of Shatner Manufacturing Company should continue to make

CISCO instead of buying it. The reason is that the company will incur additional cost of $1,160 if the management decide to buy the CISCO.

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c) SHATNER MANUFACTURING COMPANY INCREMENTAL ANALYSIS Make CISCO

Buy CISCO

Net Income Increase / (Decrease)

Total Annual Cost

84,640

85,800

(1,160)

Opportunity Cost

3,000

0

3,000

87,640

85,800

1,840

Total Cost Computation:

sh is ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m

Total Annual Cost + Opportunity = Total Cost 84,640 + 3,000 = 87,640 New Net income

= 87,640 – 85,800 = 1,840 (increase)

If Shatner Company has the opportunity to produce $3,000 of net income with the facilities currently being used to manufacture CISCO, yes indeed it will change the decision of the management since it is now advantageous to buy the CISCO as the company will received $1,840 worth of net income by doing so.

d) A non-financial factor to consider in making this decision include the possibility of hiring more employees for production, or increasing labour, maintaining standards and controlling the purchase price in the future Eventhough if the non-financial factor is non-financial we still need to compute the necessary cost in order to make decision if we will have profit or loss. Below is the computation:

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Computations:

Direct Labour Indirect Labour

4.3 0.43

Total cost of labor

4.73

If

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