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Chapter 25: 25-4TI (page 1398)

Grimm Company makes decorative wedding cakes. The company is considering buying the cakes rather than baking them, which will allow it to concentrate on decorating. The company averages 100 wedding cakes per year and incurs the following costs from baking wedding cakes:

Direct materials \(500

Direct labor 1,000

Variable manufacturing overhead 200

Fixed manufacturing overhead 1,200

Total manufacturing cost \)2,900

Number of cakes ÷ 100

Cost per cake \(29

Fixed costs are primarily the depreciation on kitchen equipment such as ovens and mixers. Grimm expects to retain the equipment. Grimm can buy the cakes for \)25.

  1. Should Grimm make the cakes or buy them? Why?
  2. If Grimm decides to buy the cakes, what are some qualitative factors that Grimm should also consider?

Short Answer

Expert verified

The company shouldcontinue making cakesrather than purchasing them from the outside.

Step by step solution

01

Meaning of Cost

The term cost refers to the amount of money spent by a business entity to acquire goods or services. In the accounting records, variable, semi-variable, and fixed costs are reported separately to understand them better and present the data.

02

Decision on buying or making the cakes

Costs

Making

Outsourcing

Difference (Making-Outsourcing)

Variable costs:

Direct materials

$500

$500

Direct labor

$,1000

$,1000

Variable manufacturing overhead

$200

$200

Purchase cost ($25*100)

$2,500

$(2,500)

Total differential cost of cakes

$1,700

$2,500

$(800)

Comment:The Grimm Company should continue to make the cakes because outsourcing will decrease the company’s profit by $800.

03

Other considerable factors

  1. Outsourcing of the cakes may lead to the loss of customers if the cakes are not delivered on time.
  2. The vendormay not be able to provide the same quality as Grimm Company to the customers.
  3. Thereliability of the vendor is the most important factor because he may take theclientsof the Grimm Company.

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Most popular questions from this chapter

Newtown Sunglasses sell for about \(154 per pair. Suppose that the company incurs the following average costs per pair:

Direct materials \)39

Direct labor 15

Variable manufacturing overhead 6

Variable selling expenses 3

Fixed manufacturing overhead 20*

Total cost \(83

* \)2,050,000 Total fixed manufacturing overhead / 102,500 Pairs of sunglasses

Newtown has enough idle capacity to accept a one-time-only special order from Water Shades for 17,000 pairs of sunglasses at \(80 per pair. Newtown will not incur any variable selling expenses for the order.

Requirements

1. How would accepting the order affect Newtown’s operating income? In addition to the special order’s effect on profits, what other (longer-term qualitative) factors should Newtown’s managers consider in deciding whether to accept the order?

2. Newtown’s marketing manager, Peter Kyler, argues against accepting the special order because the offer price of \)80 is less than Newtown’s $83 cost to make the sunglasses. Kyler asks you, as one of Newtown’s staff accountants, to explain whether his analysis is correct. What would you say?

Grimm Company makes decorative wedding cakes. The company is considering buying the cakes rather than baking them, which will allow it to concentrate on decorating. The company averages 100 wedding cakes per year and incurs the following costs from baking wedding cakes:

Direct materials \(500

Direct labor 1,000

Variable manufacturing overhead 200

Fixed manufacturing overhead 1,200

Total manufacturing cost \)2,900

Number of cakes ÷ 100

Cost per cake \(29

Fixed costs are primarily the depreciation on kitchen equipment such as ovens and mixers. Grimm expects to retain the equipment. Grimm can buy the cakes for \)25.

  1. Should Grimm make the cakes or buy them? Why?
  2. If Grimm decides to buy the cakes, what are some qualitative factors that Grimm should also consider?

What is outsourcing?

McCollum Company manufactures two products. Both products have the same sales price, and the volume of sales is equivalent. However, due to the difference in production processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.

MCCOLLUM COMPANY

Income Statement

Month Ended June 30, 2018

Total Product A Product B

Net Sales Revenue \(150,000 \)75,000 \(75,000

Variable Costs 90,000 55,000 35,000

Contribution Margin 60,000 20,000 40,000

Fixed Costs 50,000 5,000 45,000

Operating Income/(Loss) \)10,000 \(15,000 \)(5,000)

  1. If fixed costs cannot be avoided, should McCollum drop Product B? Why or why not?
  2. If 50% of Product B’s fixed costs are avoidable, should McCollum drop Product B? Why or why not?

Members of the board of directors of Security Check have received the following operating income data for the year ended May 31, 2018:

SECURITY CHECK

Income Statement

For the Year Ended May 31, 2018

Product Line

Industrial Systems

Household Systems

Total

Net Sales Revenue

\( 360,000

\) 380,000

\( 740,000

Cost of Goods Sold:

Variable

37,000

47,000

84,000

Fixed

260,000

63,000

323,000

Total Cost of Goods Sold

297,000

110,000

407,000

Gross Profit

63,000

270,000

333,000

Selling and Administrative Expenses:

Variable

64,000

73,000

137,000

Fixed

44,000

26,000

70,000

Total Selling and Administrative Expenses

108,000

99,000

207,000

Operating Income (Loss)

\) (45,000)

\( 171,000

\) 126,000

Members of the board are surprised that the industrial systems product line is not profitable. They commission a study to determine whether the company should drop the line. Company accountants estimate that dropping industrial systems will decrease fixed cost of goods sold by \(80,000 and decrease fixed selling and administrative expenses by \)12,000.

Requirements

1. Prepare a differential analysis to show whether Security Check should drop the industrial systems product line.

2. Prepare contribution margin income statements to show Security Check’s total operating income under the two alternatives: (a) with the industrial systems line and (b) without the line. Compare the difference between the two alternatives’ income numbers to your answer to Requirement 1.

3. What have you learned from the comparison in Requirement 2?
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