Question 1. Company XYZ produces widgets among other product lines. The final process of manufacturing these widgets involves assembling several components parts together. Currently, Company XYZ manufactures all these component parts bar one part, i.e. part 345.
Additional information on part 345.
Company XYZ had manufactured part 345 ten years ago. Even though it no longer produces this part internally, it still has the equipment necessary for manufacturing this part.
Lucy, the manager, is considering making this part again instead of buying it from an external supplier. The supplier charges $8 per unit of part 345. Company XYZ usually purchases 100,000 units of part 345 per annum, and proposes to continue to do so in the future.
If part 345 were to be produced in-house, it would be manufactured in batches: each batch has slightly different circumference (to fit into large, medium and small sized widgets). Therefore, 3 sizes of part 345 would have to be manufactured, i.e. large, medium and small: each size consumes the same amount of manufacturing resources. The equipment will have to be set-up each time the machinery was used to produce a different batch. The company has sufficient machining (hours) capacity to manufacture part 345 in-house.
Details of cost of manufacturing part 345:
i) Prime costs for each unit of part 345are $4.50.
ii) The company could set up 3 additionalproduction linesto produce component parts for its widgets with the available equipment: hypothetically, each line could produce 80,500 units of part 345. A supervisor would have to be hired for each production line, at a salary of $35,000/supervisor.
iii) Machining expenses (excluding supervisor/s salary in (ii) above) would amount to $1.50 per machine hour.
iv) The cost accountant has carried out a detailed analysis of other overhead costs. He explains that there are 2 types of "other overhead costs", viz., fixed costs and variable costs. He adds that the fixed costs are not permanently fixed because he purchases bundles of these fixed overhead costs as and when the factory requires these overhead services. He provides a breakdown of these overhead costs and related information in the table over the page:
Other overhead costs:
|
Activities that constitute "other overhead costs".
|
Cost driver for each activity
|
Existing factory capacity (expressed in term of cost drivers) *
|
Existing quantity of cost drivers consumed *
|
Fixed overhead component
|
Variable overhead rate
($ per unit of cost driver)
|
|
Minimum quantity/bundle of cost driver that has to be purchased to secure additional fixed overhead services**
|
Fixed overhead rate
($ per unit of cost driver)
|
|
Set ups
|
Production set ups
|
1,200
|
1,000
|
101
|
$201
|
$501
|
|
Purchasing
|
Purchase orders
|
51,000
|
48,000
|
5,000
|
11
|
1.00
|
|
Quality control
|
Inspection hours
|
21,000
|
19,000
|
2,000
|
15
|
nil
|
|
Material handling
|
Number of forklift moves
|
10,000
|
9,700
|
500
|
30
|
1.75
|
* Here "existing" means the operating situation when Part 345 was purchased from the external supplier.
v) The proposed production of 100,000 units of Part 345 would consume the following resources (cost drivers):
|
Activity
|
Consumption of cost driver |
|
Machining
|
51,000 machinehrs |
|
Set ups
|
275 production set ups |
|
Purchasing
|
4,250 purchase orders of materials |
|
Quality control
|
1,750 inspection hours |
|
Material handling
|
675 moves |
Additional information
If Part 345 were to be manufactured in-house, the firm will not purchase this part from its external supplier. Therefore purchase orders will decrease by 7,000 (which are associated with buyingPart 345 from the external supplier). Similarly, moves in handling stock of Part 345 freighted-in will decrease by 400. Inspection hours freed up from having to inspect stock of part 345 freighted in from the supplier, will be used to inspect raw material used to produce Part 345.
Required:
1.) Leaving aside qualitative considerations, should Company XYZ make or buy part 345 (based on quantitative analysis alone)? Show all relevant calculations. You must explain (in words) your numerical calculations and any assumptions you have made in your calculations.
2) Would your analysis in (1.1) be different, if Company 345 did not have the capacity of machining hours to manufacture part 345? Explain in full in words- do not carry out additional calculations.
2. Company QR has 5 departments that are in a sequential production relationship. That is, the WIP of Dept 1 becomes one of the inputs of Dept 2 (i.e. Dept 2's transferred-in cost); the WIP of Dept 2 becomes one of the inputs of Dept 3 and so on.
The accountant for Company QR wants to evaluate the performance of each department by producing department based Profit and Loss statements. The manager of each dept will be held responsible for his/her dept's profit or loss. The accountant wants to minimise the cost of setting up this control system by using the absorption costs figures generated for the financial accounting system to produce these Profit and Loss statements.
Required.
1. Do you agree with the accountant's intention to use absorption cost figures to produce the departmental Profit and Loss statements?
2. Justify your answer in (2.1) by critically evaluating the strengths and weaknesses of using Profit and Loss statements based on absorption costing for control purposes, i.e. to manage management/departmental performance.
3. Regardless of your answer in 2.1, explain how you could improve the accountant's proposed system. Explain how your system would function.
Critically evaluate the strengths and weaknesses of your suggested improvement.