Question 4:

Armidale Incorporation (AI) normally manufactures tyres for its motorbikes. For the current year, AI is producing motorbikes at its full capacity with a maximum output it can produce with its current fixed costs structure. AI is allocating variable manufacturing overhead (MOH) costs to its output at 30% of direct labor (DL) costs. For AI, per tyre direct materials (DM) is $3 per tyre and DL cost is $3.60 per tyre. AI normally produces 200,000 tyres in a year.

Another player in the industry, Tamworth Tyres (TT) sends a proposal to the management accountant at AI offering to produce tyres for AI at $8 per tyre.

If AIs management accountant agrees to TTs offer and the company accepts the offer, AI will not need to incur any of its variable manufacturing costs noted above. However, AIs $84,000 fixed MOH costs that have been committed to the production of tyres could not be saved and the company will continue to incur this costs.

Required: See next page for requirements a and b

a. Providing your calculations and based on the relevant costs analysis, should AI accept TTs offer? Use the template below to fill in correct figures (use a separate space on your assignment for any workings/calculations):

Make Buy

Direct materials ( x ) . .

Direct labor ( x ) ..

Variable manufacturing costs:

( x ) ..

Purchase price ( x ) .................

Total annual cost .. $ $

b. Would you support AIs decision to buy tyres from TT (i.e. outsource tyres production) and not manufacture in-house? Provide justification for your answer.