Exercise 7-5 Pottery Ranch Inc. has been manufacturing its own finials for its c

Question

Exercise 7-5 Pottery Ranch Inc. has been manufacturing its own finials for its curtain rods. The company is currently operating at 100% of capacity, and variable manufacturing overhead is charged to production at the rate of 70% of direct labor cost. The direct materials and direct labor cost per unit to make a pair of finials are $4 and $5, respectively. Normal production is 30,000 curtain rods per year. A supplier offers to make a pair of finials at a price of $12.95 per unit. If Pottery Ranch accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $45,000 of fixed manufacturing overhead currently being charged to the finials will have to be absorbed by other products. (a) Prepare an incremental analysis to decide if Pottery Ranch should buy the finials. (Round answers to 0 decimal places, e.g. 1250. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).) Make Buy Net Income Increase (Decrease) Direct materials $ $ $ Direct labor Variable overhead costs Fixed manufacturing costs Purchase price Total annual cost $ $ $ (b) Should Pottery Ranch buy the finials? NoYes, Pottery Ranch should buynot buy the finials. (c) Would your answer be different in (b) if the productive capacity released by not making the finials could be used to produce income of $20,000? YesNo, income would increasedecrease by $

Explanation / Answer

a)

b) Buying the product would result in a differential loss of $13500. Hence it is better to manufacture.

#Since Fixed Cost is unavoidable it is ignored for the purpose of decision making.

c)

In this case it is better to buy the product since it would result in a incremental profit of $600.

Particulars Make Buy Difference Direct Material $4*30000 = $120000 - $120000 Direct Labour $5*30000 = $150000 - $150000 Variable Manufacturing Overheads $5*70%*30000 = $105000 - $105000 Fixed Manufacturing Overheads - - - Purchase Price $12.95*30000 = $388500 -388500 Total $375000 $388500 -13500

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