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BUS 5110 - Managerial Accounting - Written Assignment Unit 4

This document analyzes the costs of a vacuum manufacturer making engines internally versus outsourcing engine production. It conducts a differential analysis comparing the annual production costs of making engines in-house versus buying them from an external supplier. The analysis finds that making engines internally would cost $4,275,000 annually while outsourcing would cost $4,350,000. Therefore, the document recommends that the vacuum manufacturer make the engines internally to save $75,000 per year.

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281 views

BUS 5110 - Managerial Accounting - Written Assignment Unit 4

This document analyzes the costs of a vacuum manufacturer making engines internally versus outsourcing engine production. It conducts a differential analysis comparing the annual production costs of making engines in-house versus buying them from an external supplier. The analysis finds that making engines internally would cost $4,275,000 annually while outsourcing would cost $4,350,000. Therefore, the document recommends that the vacuum manufacturer make the engines internally to save $75,000 per year.

Uploaded by

Leslie
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Differential Analysis

Written Assignment Unit 4

Managerial Accounting

Term 4 2021

BUS 5110

University of the People

April 2021
Manufacturing company usually make their own products, that’s why they are called

manufacturer in the first place. However, as time goes by, new technology evolved and there are

some circumstances that can affect the business’ profitability that’s why some companies

consider outsourcing. “Outsourcing is the business practice of hiring a party outside a company

to perform services and create goods that traditionally were performed in-house by the

company's own employees and staff” (Twin, 2021). Usually, businesses do outsource to avoid

expenses associated with overhead, salaries, and technology. However, it doesn’t always mean

that if the company saves some expenses the profitability will increase. That is why companies

do differential analysis first before deciding whether to make or buy the product. When we say

make-or-buy decision that means an “act of choosing between manufacturing a product in-house

or purchasing it from an external supplier” (Kenton, 2021).

To help the vacuum manufacturer decide whether to make or buy engines, we need to do

differential analysis first. To do this, we need to outline the needed cost or revenue data (. Since

the production of 50,000 units is an annual based, therefore all data must be annualized to get a

correct calculation. The following variable monthly cost will be converted to an annual value:

• Direct Materials = $75,000 * 12 = $900,000 ÷ 50,000 units = $18/unit

• Direct Labor = $100,000 * 12 = $1,200,000 ÷ 50,000 units = $24/unit

• Total = $175,000 * 12 = $2,100,000

• Variable Factory Overhead = $7.50 * 50,000 = $375,000 ÷ 50,000 units = $7.5/unit

• Fixed factory overhead = 150% of direct labor cost per unit

Therefore, we have to solve for direct labor cost per unit

Total direct labor cost for the year = $1,200,000

This means that $1,200,000 ÷ 50,000 units = $24


The direct labor cost per unit will be $24

To get the fixed factory overhead = 150% of $24 = $36/ unit

Total Annual Fixed factory overhead = $36 * 50,000 = $1,800,000

• Costs to buy engines from outside / outsourcing cost = $60 * 50,000 = $3,000,000

• 75% fixed costs of annual fixed factory overhead = 75% * 1,800,000 = $1,350,000

(this will continue regardless they make or buy the engines)

Table 1.1 Annual Production Costs Analysis from above data


Annual Cost at
Variable Production Costs Per Unit
50,000 units
Direct Materials $ 18.00 $ 900,000.00
Direct Labor $ 24.00 $ 1,200,000.00
Manufacturing Overhead $ 7.50 $ 375,000.00
Fixed Production Costs
Factory overhead $ 36.00 $ 1,800,000.00
Total Production Cost $ 4,275,000.00

Table 1.2 Make-or-Buy Differential Analysis for vacuum manufacturer


Variable Production Alternative 1 Alternative 2 Differential Alternative
Costs (Make Internally) (Outsource) Amount 1 is
Cost to buy from
$ 0 $ 3,000,000
outside $ (3,000,000) Lower
Direct Materials $ 900,000 $ - $ 900,000 Higher
Direct Labor $ 1,200,000 $ - $ 1,200,000 Higher
Manufacturing
Overhead $ 375,000 $ - $ 375,000 Higher
Fixed Production
Costs
Factory overhead $ 1,800,000 $ 1,350,000 $ 450,000 Higher
Total Production
Cost $ 4,275,000 $ 4,350,000 $ (75,000) Lower
After analyzing the figures shown in Table 1.2, I recommend that they should make their engines

internally rather than buying from outside. If they outsource the engines, they will spend

$75,000. To explain this further look at Table 1.3.

Table 1.3 Results of Outsourcing Manufacturing of Engine Component


Cost increase to buy from outside $ (3,000,000)
Direct materials cost savings 900,000
Direct labor cost savings 1,200,000
Manufacturing overhead cost savings 375,000
Factory overhead (rent, lease, salary) cost savings 450,000
Cost increase from outsourcing to third party $ (75,000)

Outsourcing to third-party apparently has a negative impact on profit

Whether they make or buy the engines, they still need to pay for the rent. So, if the factory space

is suitable for lease, maybe they can lease it to other company and save that money. If such

opportunity costs exist and if they can reduce the outsourcing cost, then the management can

weigh in other factors whether to make or buy the engine.

References:

Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for Managers.

https://2012books.lardbucket.org/books/accounting-for-managers/index.html

Twin, A. (2021, May 2). Why Companies Use Outsourcing. Investopedia.

https://www.investopedia.com/terms/o/outsourcing.asp.

Kenton, W. (2021, February 8). Make-or-Buy Decision. Investopedia.

https://www.investopedia.com/terms/m/make-or-buy-

decision.asp#:~:text=Key%20Takeaways-
,A%20make%2Dor%2Dbuy%20decision%20is%20an%20act%20of%20choosing,house%

20versus%20buying%20it%20elsewhere.

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