Managerial Accounting Business Case
Essay by amcdl • February 2, 2013 • Research Paper • 1,587 Words (7 Pages) • 1,598 Views
Mr. Peter Perfecto, the general manager, is facing a certain predicament on whether or not to buy its containers from an outside source or continue to produce its own containers. Containers, Inc. has offered proposals, and comparing it to the year's operations of the Packaging Container Department of the company, it may seem plausible to close the department and sign the contract s offered by Containers, Inc., based solely on the figures that have been presented. However, making a decision based on the values presented should not be made for there are costs that should be properly segregated. Taking great considerations on the discussion between Mr. Perfecto and Mr. Allan Alvarez, the manager of the department, there are four possible alternatives that are available to the company: alternative A: make own containers and perform own maintenance, alternative B: make own containers; avail maintenance services from Containers, Inc., alternative C: buy containers from Containers, Inc., yet manage own maintenance, and alternative D: buy containers and avail maintenance service from Containers, Inc.
Now that the four alternatives have been identified, two steps are necessary to classify costs that are relevant in decision making. First, exclude costs and benefits that are irrelevant. The department rent expense is considered an irrelevant cost, because it will continue to be incurred whether the company decides to produce the containers or have Containers, Inc. make it for them. General overhead expense will still be incurred whether the company decides to produce the containers or not, thus, making it an irrelevant cost. Depreciation on machinery is a sunk cost, which makes it an irrelevant cost. The remaining costs and benefits will be utilized in making the decision.
Let us now look into each of the alternatives, which contains the relevant cost analysis of the make or buy decision.
Alternative A: Make own containers and perform own maintenance
Materials P 7,000,000
Labour
Supervisor 500,000
Workers 4,500,000
Departmental Manufacturing Overhead
Manager's Salary 800,000
Maintenance of Machinery 360,000
Others 1,575,000
Add: Opportunity Cost- Rent of another Warehouse 850,000
Total costs of production and maintenance P 15,585,000
As seen in alternative A, there is an opportunity cost that is added. Here, if the company decides to produce containers, the space will be used for production. However, if the company decides to buy containers from Containers, Inc., the space will be used for warehousing.
Alternative B: Make own containers; avail maintenance services from Containers, Inc.
Materials P 6,300,000
Labour
Supervisor 500,000
Workers 3,600,000
Departmental Manufacturing Overhead
Manager's Salary 800,000
Maintenance of Machinery 360,000
Others 925,000
Add: Opportunity Cost- Rent of another Warehouse 850,000
Maintenance Costs of Containers Inc. 3,750,000
Total costs of production and maintenance P 17,085,000
In alternative B, there is still an opportunity cost of the rent, if the company decides to make their own containers and avail for the maintenance services from Containers, Inc. Production is 90 percent of materials since the maintenance will be done by Containers, Inc. For this alternative 80 percent or four-fifths of the workers will be needed, because the company will just be producing their own containers. If the company chooses to have their maintenance done by Containers, Inc., the other department manufacturing overhead would be P1,575,000 less P650,000. The amount of P650,000 is incurred if the company decides to just do the maintenance work, while the containers are made by Containers, Inc. Maintenance cost of Containers, Inc. is added, since they will be just doing the maintenance work in this alternative.
Alternative C: Buy containers from Containers Inc., yet manage own maintenance
Materials P 700,000
Labour
Supervisor 500,000
Workers 900,000
Departmental Manufacturing Overhead
Manager's Salary 0
Maintenance of Machinery 0
Severance Pay 160,000
Others 650,000
Add: Opportunity Cost- Rent of another Warehouse 850,000
Cost of supplying containers from outside 12,500,000
Less: Proceeds from sale of equipment (2,000,000)
Total costs of production and maintenance P 14,260,000
For alternative C, we have taken into account the considerations of Mr. Perfecto and Mr. Alvarez if the company were to manage their own maintenance and to buy containers from Containers, Inc. The maintenance is ten percent of materials, which will be used for this alternative. Only one-fifth or 20 percent of workers will be needed. Pension cost is not included because if they choose this alternative, the workers that have been with them the longest will be kept, thus saving the pension cost. The severance pay represents the severance paid to the workers that have been discharged due to the decision of buying the containers from Containers, Inc., yet managing their own maintenance. The cost for the other department manufacturing overhead will incur a cost of P650,000, which is given in the case. Opportunity cost is added because the company will still continue to use it. Containers, Inc. proposed to supply all the new containers required, which will
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