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 $4 and $5, respectively. Normal production is 26,400 curtain rods per year. A supplier offers to make a pair of finials at a price of $13.30 per unit. If Pottery Ranch accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $40,400 of fixed manufacturing overhead currently being charged to the finials will have to be absorbed by other products.

Required:
Prepare the incremental analysis for the decision to make or buy the finials.

Pottery Ranch Inc.

Incremental Analysis

                                                              Make       Buy      Incremental

Production costs:

Variable manufacturing costs per unit:

Direct materials per unit                      $4.00

Direct labor per unit                            $5.00

Variable manufacturing per unit        $3.05

Total variable manufacturing costs  $12.05         $13.30        $1.25

Annual units of curtain rods            26,400        26,400     26,400

Variable manufacturing costs       $318,120     $351,120   $33,000

Explanation:

a) Data and Calculations:

Production capacity = 100%

Variable manufacturing overhead = 61% of direct labor cost

Direct materials per unit = $4

Direct labor per unit = $5

Variable manufacturing per unit = $3.05 (61% of $5)

Total variable manufacturing cost per unit = $12.05

Normal production per year = 26,400 units

Total variable manufacturing costs = $318,120 ($12.05 * 26,400)

Fixed manufacturing overhead = $40,400

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