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Chapter 25: Q25-7E (page 1409)

Priscilla Smiley manages a fleet of 250 delivery trucks for Daniels Corporation. Smiley must decide whether the company should outsource the fleet management function. If she outsources to Fleet Management Services (FMS), FMS will be responsible for maintenance and scheduling activities. This alternative would require Smiley to lay off her five employees. However, her own job would be secure; she would be Daniels’s liaison with FMS. If she continues to manage the fleet, she will need fleet management software that costs \(9,500 per year to lease. FMS offers to manage this fleet for an annual fee of \)300,000. Smiley performed the following analysis:

Retain in-house Outsource to FMS Difference

Annual leasing fee for \(9,500 \)9,500

Software

Annual maintenance of

Trucks 147,000 147,000

Total annual salaries of

Five laid-off employees 185,000 185,000

Fleet management

Service’s annual fee \(300,000 (300,000)

Total differential cost of

Outsourcing \)341,500 \(300,000 \)41,500

Requirements

1. Which alternative will maximize Daniels’s short-term operating income?

2. What qualitative factors should Daniels consider before making a final decision?

Short Answer

Expert verified

Answer

Outsourcing to FMS is the best alternative to Daniels Corporation because it costs less than in-house retaining.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Differential Analysis

Differential analysis is the technique used in thecost accounting branch to analyze the best alternative from the available alternatives. Under this analysis approach, asunk cost is ignored while making the final decision.

02

Maximization of short-term operating income

According to the data mentioned above, outsourcing to FMS is the best alternative that will maximize the operating income of Daniels Corporation. Retaining in-house variable costing is $341,500, which ishigher than the outsourcing to FMS, i.e., $300,000.

03

Consideration of qualitative factors

The following qualitative factors should be considered before making the final decision:

  • As mentioned in the data, theimpact on other employees’ morale should be considered after laying off the five employees.
  • The company must consider the factors associated with thecontrol of the maintenance and scheduling activities that may be reduced.
  • Most importantly, the company requires to consider theprobable increase in the FMS’s service revenue.

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Most popular questions from this chapter

What are joint costs? How do they affect the sell or process further decision?

Thomas Company makes a product that regularly sells for \(12.50 per unit. The product has variable manufacturing costs of \)8.50 per unit and fixed manufacturing costs of \(2.00 per unit (based on \)200,000 total fixed costs at current production of 100,000 units). Therefore, the total production cost is \(10.50 per unit. Thomas Company receives an offer from Wesley Company to purchase 5,000 units for \)9.00 each. Selling and administrative costs and future sales will not be affected by the sale, and Thomas does not expect any additional fixed costs.

1. If Thomas Company has excess capacity, should it accept the offer from Wesley? Show your calculations.

2. Does your answer change if Thomas Company is operating at capacity? Why or why not?

Suppose Roasted Pepper restaurant is considering whether to (1) bake bread for its restaurant in-house or (2) buy the bread from a local bakery. The chef estimates that variable costs of making each loaf include \(0.52 of ingredients, \)0.27 of variable overhead (electricity to run the oven), and \(0.79 of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor, Roasted Pepper assigns \)0.96 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge $1.78 per loaf.

Requirements

1. What is the full product unit cost of making the bread in-house?

2. Should Roasted Pepper bake the bread in-house or buy from the local bakery? Why?

3. In addition to the financial analysis, what else should Roasted Pepper consider when making this decision?

Mary Tan is the controller for Duck Associates, a property management company in Portland, Oregon. Each year, Tan and payroll clerk Toby Stock meet with the external auditors about payroll accounting. This year, the auditors suggest that Tan consider outsourcing Duck Associates’s payroll accounting to a company specializing in payroll processing services. This would allow Tan and her staff to focus on their primary responsibility: accounting for the properties under management. At present, payroll requires 1.5 employee positions—payroll clerk Toby Stock and a bookkeeper who spends half her time entering payroll data in the system.

Tan considers this suggestion, and she lists the following items relating to outsourcing payroll accounting:

  1. The current payroll software that was purchased for \(4,000 three years ago would not be needed if payroll processing were outsourced.

  2. Duck Associates’ bookkeeper would spend half her time preparing the weekly payroll input form that is given to the payroll processing service. She is paid \)450 per week.

  3. Duck Associates would no longer need payroll clerk Toby Stock, whose annual salary is \(42,000.

  4. The payroll processing service would charge \)2,000 per month.

Requirements

1. Would outsourcing the payroll function increase or decrease Duck Associates’ operating income?

2. Tan believes that outsourcing payroll would simplify her job, but she does not like the prospect of having to lay off Stock, who has become a close personal friend. She does not believe there is another position available for Stock at his current salary. Can you think of other factors that might support keeping Stock, rather than outsourcing payroll processing? How should each of the factors affect Tan’s decision if she wants to do what is best for Duck Associates and act ethically?

Top managers of Video Avenue are alarmed by their operating losses. They are considering dropping the DVD product line. Company accountants have prepared the following analysis to help make this decision:

VIDEO AVENUE

Income Statement

For the Year Ended December 31, 2018

Total Blu-ray Discs DVD Discs

Net Sales Revenue \(437,000 \)308,000 \(129,000

Variable Costs 250,000 154,000 96,000

Contribution Margin 187,000 154,000 33,000

Fixed Costs:

Manufacturing 132,000 76,000 56,000

Selling & Administrative 65,000 51,000 14,000

Total Fixed Expenses 197,000 127,000 70,000

Operating Income (Loss) \)(10,000) \(27,000 \)(37,000)

Total fixed costs will not change if the company stops selling DVDs.

Requirements

1. Prepare a differential analysis to show whether Video Avenue should drop the DVD product line.

2. Will dropping DVDs add $37,000 to operating income? Explain.
See all solutions

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