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 61% of direct labor cost. The direct materials and direct labor cost per unit to make a pair of finials are $3.96 and $4.89, respectively. Normal production is 32,300 curtain rods per year.

A supplier offers to make a pair of finials at a price of $12.89 per unit. If Pottery Ranch accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $46,500 of fixed manufacturing overhead currently being charged to the finials will have to be absorbed by other products.

(a) Prepare an incremental analysis to decide if Pottery Ranch should buy the finials.

Make Buy Net Income Increase (Decrease)

Direct Materials

Direct Labor

Variable Overhead Costs

Fixed Manufacturing Costs

Purchase Price

Total Annual Cost

(b) Should Pottery Ranch buy the finials?

(Yes/No), Potter Ranch should (buy/not 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 $42,044?

(Yes/No), income would (decrease/increase) by $ __

Answer 1

SOLUTION

(A)

Particulars	Make ($)	Buy ($)	Net income increase / (decrease)
Direct materials (32,300 * $3.96)	127,908
Direct Labor (32,300 * $4.89)	157,947
Variable Overhead Costs ($157,947*61%)	96,348
Fixed Manufacturing Costs	46,500	46,500
Purchase Price (32,300 * $12.89)		416,347
Total Annual Cost	428,703	462,847	34,144

(B) No, Pottery Ranch should not buy the finials as annual cost is increasing.

(C)

Particulars	Make ($)	Buy ($)	Net income increase / (decrease)
Direct materials (32,300 * $3.96)	127,908
Direct Labor (32,300 * $4.89)	157,947
Variable Overhead Costs ($157,947*61%)	96,348
Fixed Manufacturing Costs	46,500	46,500
Purchase Price (32,300 * $12.89)		416,347
Less: Income		(42,044)
Total Annual Cost	428,703	420,803	(7,900)

Yes, Net income would decrease by $7,900