Question

QUESTION Matchless Corporation manufactures radios that it uses in several of its products. Osman Budi, the company’s financial manager, has been assigned the task of determining whether to continue manufacturing the radios or to buy them from an outside source. The following information is available: • The company needs 20,000 radios per year. The radios can be purchased from an outside supplier at a cost of RM60 per unit. • The cost of manufacturing the radios is RM85 per unit, detailed as follows: Direct materials RM400,000 Direct labor RM500,000 Variable manufacturing overhead RM350,000 Fixed manufacturing overhead RM450,000 Total manufacturing costs RM1,700,000 • Discontinuing the manufacture of radios will eliminate all the raw materials and direct labor cost but will eliminate only 80 per cent of the variable manufacturing overhead costs. The remaining amount of variable manufacturing costs will continue to be incurred. • If the radios are purchased from an outside supplier, machinery used in the production of radios will be sold at its book value. Accordingly, no gain or loss will be recognized. The sale of this machinery would also eliminate RM5,000 in fixed manufacturing costs associated with depreciation. No other reductions in fixed manufacturing will occur from discontinuing the production of radios. Mr. Saad, the production manager of Matchless Corporation, stopped by at Osman Budi’s office to voice his concern regarding the outsourcing of radios to outside supplier. Mr. Saad commented: “I am really concerned about outsourcing of the radios. I have a son-in-law and a nephew who work at our radios’ factory. They could lose their jobs if we buy the radios from the outside supplier. I really would appreciate anything you could do to make sure the cost analysis comes out right to show we should continue making the radios”. Required: a. Basing solely on the financial results, recommend whether Matchless Corporation should make the radios or purchase them from outside supplier. Prepare an analysis of relevant cost to support you answer. (7 marks) b. Assume that if the radios are purchased from the outside supplier, the factory space previously used to produce radios can be converted to a storage space and can be rented to generate a rental revenue amounted to RM185,000 per year. However, this requires a small renovation at cost of RM80,000. In addition, there will be a maintenance cost amounted to RM40,000 per year. Would this new assumption change your recommendation, as in requirement (a), as to whether to make or buy the radios? Explain and support your answer with relevant cost analysis. (6 marks) Please answer the b part only assume that ....

Answer 1

a)
	Make the Radios	Buy the Radios	Incremental Analysis
Manufacturing costs for 20,000 radios:
Direct materials	400,000.00		400,000.00
Direct Labor	500,000.00		500,000.00
Factory Overhead:			-
Variable [$350,000 - ($350,000 × 80%)]	350,000.00	70,000.00	280,000.00
Fixed [$450,000 - $5,000]	450,000.00	445,000.00	5,000.00
Cost to purchase 20,000 radios at $60 each		1,200,000.00	(1,200,000.00)
Totals	1,700,000.00	1,715,000.00	(15,000.00)
Based upon the above analysis, management will Save $15,000  by continuing to manufacture radios rather than buying them from an outside source
b)
Effect of alternative use of factory space:
Incremental cost of buying radios from an outside source (see part a )		(15,000.00)
Add: Contribution margin of alternative use of factory space
Revenue	185000
Less: Variable Cost	40000	145,000.00
Incremental benefit of buying radios from an outside source and using space to produce additional timepieces		130,000.00
RM80,000 is deemed to be sunk cost