Question

Sarasota Bicycles has been manufacturing its own wheels for its bikes. The company is currently operating at 100% capacity, and variable manufacturing overhead is charged to production at the rate of 30% of direct labor cost. The direct materials and direct labor cost per unit to make the wheels are $3.00 and $3.60 respectively. Normal production is 200,000 wheels per year.

A supplier offers to make the wheels at a price of $8 each. If the bicycle company accepts this offer, all variable manufacturing costs will be eliminated, but the $84,000 of fixed manufacturing overhead currently being charged to the wheels will have to be absorbed by other products.

Required:

a.   Prepare an incremental analysis for the decision to make or buy the wheels.

b.   Should Sarasota Bicycles buy the wheels from the outside supplier? Justify your answer.

Answer 1

a)

	Make (200,000 wheels)	Buy(200,000 wheels)
Direct Material = 200,000 x $3	$600,000	-------------------------------
Direct Labour = 200,000 x $3.6	$720,000	-------------------------------
Variable Manufacturing Overhead = $720,000 x 30%	$216,000	-------------------------------
Buying Price = 200,000 x $8	-------------------------------	$1,600,000
Total annual cost for 200,000 wheels	$1,536,000	$1,600,000

b) Sarasota Bicycles should continue to manufacture wheels because if accepting the proposal of outsider supplier, Sarasota Bicycles net income will decrease by $64,000 ($1,600,000 - $1,536,000). So, continue to manufacturing wheels and do not accept the proposal of ouside supplier.