Written Assignment 4

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Introduction
We used a "make or buy differential analysis" to tackle this case study. We must lay down
the required cost or revenue information in order to do that precisely.
First, since the production of 50,000 units is based on an annual cycle, all provided data must
be annualized to provide an accurate figure.
In light of this, the annual variable monthly expenditures would be the following:
Direct Materials = $75,000 * 12 = $900,000
Direct Labour = $100,000 * 12 = $1,200,000
Total = $175,000 * 12 = $2,100,000
Variable Factory Overhead = $7.50 per unit, in same vein, total variable factory overhead =
$7.50 * 50,000 = $375,000 for the year.
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
The direct labor cost per unit will be 1,200,000 / 50,000 = $24
Fixed factory overhead (rent, lease, salary) per unit = 150% of $24 = $36
Total Annual fixed factory overhead = $36 * 50,000 = $1,800,000
This then implies that unit costs for direct materials will be $18 also
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 = $1,350,000While we
do not necessarily need this in the analysis to follow, the sales revenue annual = $150 per unit
* 50,000 units = $7,500,000. We do not need this because the focus of make-or-buy decisions
is on product costs, and because sales revenue is not differential to this decision, it is not
necessary to include sales revenue in the analysis (Heisinger & Hoyle, n.d.).
Table 1.1 Annual Production Costs Analysis from above data

Total Annual cost
@50.000 units
Per unit
Variable production costs

$900,000
Direct materials $18
2
Direct labor 24 1,200,000
Manufacturing overhead 7.5 375,000

Fixed production costs
Factory overhead (rent, lease, salary) 36 1,800,000

Total production costs $4,275,000
Table 1.2 Make-or-Buy Differential Analysis for vacuum manufacturer

Cost to buy engine from outside $0.00 $3,000,000 $(3,000,000) Lower
Direct materials
900,000 0
900,000 Higher
Direct labor
1,200,000 0
1,200,000 Higher
Manufacturing overhead
375,000 0
375,000 Higher
Factory overhead (rent, lease, salary)
1,800,000
1,350,000
450,000 Higher
Total production costs $4,275,000 $4,350,000 $ (75,000) Lower
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Alternative Alternative 2 Differential

1 Amount
(Buy from Alternative
(Make outside) 1 is
Internally
Variable production costs

$3,000,000 $(3,000,000 Lower
Cost to buy engine from outside
$0.00 )
0 Higher
Direct materials
900,000 900,000
0 Higher
Direct labor
1,200,000 1,200,000
0 Higher
Manufacturing overhead
375,000 375,000
1,350,000 Higher
Factory overhead (Rent, lease, salary)
1,800,000 450,000
$4,350,000 Lower
Total production costs
$4,275,000 $(75,000)
Recommendation
Making the engine components internally is the best alternative. This alternative
results in total costs of $4,275,000, providing $75,000 in savings compared to the $4,350,000
cost of outsourcing the production of the engine components to a third-party manufacturer.
Making the engine components internally is the best alternative. This alternative results in
total costs of $4,275,000, providing $75,000 in savings compared to the $4,350,000 cost of
outsourcing the production of the engine components to a third-party manufacturer.
Table 1.3 Summary of Differential Analysis for vacuum manufacturer
Result of Outsourcing Manufacturing of Engine Component

4
Cost increase to buy from outside $(3,000,000)
Direct materials cost saving

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.
Other factors for consideration

If they were to outsource, we are unsure if they could rent the space utilized to make the
engine component and offset the negative effects from that location. However, we do know
the specifics of the factory's size. The management can consider additional factors such as the
capability of existing staff to undertake manufacturing the engine components, the
availability of working capital, and the cost of any loans that may be necessary to inform
their decision on whether to make or buy if such opportunity costs exist and can reduce the
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cost increase from outsourcing considerably to between $2000 and $5000 (Lumen Learning,
n.d.-a).
References
How are relevant revenues and costs used to make decisions? (n.d.).
https://2012books.lardbucket.org/books/accounting-for-managers/s11-how-are-
relevant-revenues-and-.html
Course Sidekick. (n.d.).
https://courses.lumenlearning.com/sac-managacct/chapter/differential-analysis-and-
its-application-to-managerial-decision-making/
Melović, B., Veljkovic, S. M., Cirovic, D., & Radojičić, I. S. (2020). Managerial decision-
making process in the modern business conditions in the EU. In IGI Global eBooks
(pp. 324–348). https://doi.org/10.4018/978-1-7998-1188-6.ch020

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Table 1.1 Annual Production Costs Analysis from above data

Variable production costs

Direct labor 24 1,200,000

Manufacturing overhead 7.5 375,000

Factory overhead (rent, lease, salary) 36 1,800,000

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

Alternative Alternative 2 Differential

Variable production costs

Fixed production costs

Table 1.3 Summary of Differential Analysis for vacuum manufacturer

Result of Outsourcing Manufacturing of Engine Component

Cost increase to buy from outside $(3,000,000)

Direct materials cost saving

Direct labor cost savings 1,200,000

Manufacturing overhead cost savings 375,000

Factory overhead (rent, lease, salary) cost savings 450,000

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

Other factors for consideration

Course Sidekick. (n.d.).

(pp. 324–348). https://doi.org/10.4018/978-1-7998-1188-6.ch020

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