Question

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 50% 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 25,000 curtain rods per year.

A supplier offers to make a pair of finials at a price of $12.75 per unit. If Pottery Ranch accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $40,000 of fixed manufacturing overhead currently being charged to the finials will have to be absorbed by other products.

(a)

Prepare the incremental analysis for the decision to make or buy the finials.

(b)

Should Pottery Ranch 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 $35,750?

Answer 1

Ans:

Answer to Part 1
Particulars	Make	Buy	Net Income Increase/ (Decrease)
Direct Material (4*25000)	100,000		100,000
Direct Labor (5*25000)	125,000		125,000
Variable Manufacturing costs (125000*50%)	62500		62500
Fixed manufacturing costs	40,000	40,000	0
Purchase price (12.75*25000)		318750	-318750
Total Annual Cost	327500	358750	-31250

Answer to Part 2

NO, Pottery Ranch should NOT BUY the finials

Answer to Part 3
Additional Income	35750
Less: Additional cost incurred in buying the finials	31250
Net Income (48014-40014)	4500
YES, income would Increase by $ 4500