Question
anagers often have to choose betweenmutually exclusivealternatives. The first step is to identify the alternatives and the relevant revenues and costs of each option. The
anagers often have to choose betweenmutually exclusivealternatives. The first step is to identify the alternatives and the relevant revenues and costs of each option. The next step is to compare the alternatives. This is calleddifferential
analysis, or incremental analysis. The concept is to determine thedifferential income or lossfrom choosing one option over the other. If irrelevant costs are included in one option, the costshould also be included in the other options for comparison purposes.
Make or buy decisions, sell or process further decisions, lease or buy decisions, whether to accept an order at a discounted price, and when to replace equipment, are all examples of common decisions where differential analysis is used.
Many formats may be used. Clickherefor a template that includes all revenues and costs. Clickherefor a template with relevant costs only.
Make or Buy Decision:
Zee-Drive Ltd. is a computer manufacturer. One of the items they make is monitors. Zee-Drive has the opportunity to purchase 17,000 monitors from an outside supplier for $197 per unit. One of the company's cost-accounting interns prepared the following schedule of Zee-Drive's cost to produce 17,000 monitors:
Total cost of producing 17,000 monitors Unit cost
Direct materials $1,955,000 $115
Direct labor 1,207,000 71
Variable factory overhead 476,000 28
Fixed manufacturing overhead 459,000 27
Fixed non-manufacturing overhead680,000 40
$4,777,000 $281
Youare asked to look over the intern's estimate before the information is shared with members of management who will decide to continue to make the monitors or buy them. The company's controller believes that the estimate may be incorrect because it includes costs that are not relevant. If Zee-Drive buys the monitors, the direct labor force currently employed in producing the monitors will be terminated and there would be no termination costs incurred. There are no materials on hand and no commitments to suppliers to purchase materials, so all materials would need to be purchased to make the monitors. Variable overheads are avoidable if monitors are bought. Fixed manufacturing overhead costs would be reduced by $53,300, but non-manufacturing costs would remain the same if monitors are bought.
Fill in the differential analysis.
Make or Buy Decisions
Differential Analysis Report
Purchase price of 17,000 monitors $
Differential cost to make: $
Direct materials $
Direct laborOverhead $ $
Differential income (loss) from making monitors $
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