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Grimm Company makes decorative wedding cakes. The company is considering buying the cakes rather than baking them, which will allow it to concentrate on decorating. The company averages 100 wedding cakes per year and incurs the following costs from baking wedding cakes:

Direct materials \(500

Direct labor 1,000

Variable manufacturing overhead 200

Fixed manufacturing overhead 1,200

Total manufacturing cost \)2,900

Number of cakes ÷ 100

Cost per cake \(29

Fixed costs are primarily the depreciation on kitchen equipment such as ovens and mixers. Grimm expects to retain the equipment. Grimm can buy the cakes for \)25.

  1. Should Grimm make the cakes or buy them? Why?
  2. If Grimm decides to buy the cakes, what are some qualitative factors that Grimm should also consider?

Short Answer

Expert verified

The company shouldcontinue making cakesrather than purchasing them from the outside.

Step by step solution

01

Meaning of Cost

The term cost refers to the amount of money spent by a business entity to acquire goods or services. In the accounting records, variable, semi-variable, and fixed costs are reported separately to understand them better and present the data.

02

Decision on buying or making the cakes

Costs

Making

Outsourcing

Difference (Making-Outsourcing)

Variable costs:

Direct materials

$500

$500

Direct labor

$,1000

$,1000

Variable manufacturing overhead

$200

$200

Purchase cost ($25*100)

$2,500

$(2,500)

Total differential cost of cakes

$1,700

$2,500

$(800)

Comment:The Grimm Company should continue to make the cakes because outsourcing will decrease the company’s profit by $800.

03

Other considerable factors

  1. Outsourcingof the cakes may lead to the loss of customers if the cakes are not delivered on time.
  2. The vendormay not be able to provide the same quality as Grimm Company to the customers.
  3. The reliability of the vendor is the most important factor because he may take theclientsof the Grimm Company.

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Most popular questions from this chapter

NaturalMaid processes organic milk into plain yogurt. NaturalMaid sells plain yogurt to hospitals, nursing homes, and restaurants in bulk, one-gallon containers. Each batch, processed at a cost of \(840, yields 300 gallons of plain yogurt. NaturalMaid sells the one-gallon tubs for \)5 each and spends \(0.14 for each plastic tub. NaturalMaid has recently begun to reconsider its strategy. NaturalMaid wonders if it would be more profitable to sell individual-size portions of fruited organic yogurt at local food stores. NaturalMaid could further process each batch of plain yogurt into 6,400 individual portions (3/4 cup each) of fruited yogurt. A recent market analysis indicates that demand for the product exists. NaturalMaid would sell each individual portion for \)0.58. Packaging would cost \(0.10 per portion, and fruit would cost \)0.11 per portion. Fixed costs would not change.

Should NaturalMaid continue to sell only the gallon-size plain yogurt (sell as is) or convert the plain yogurt into individual-size portions of fruited yogurt (process further)? Why?

Elm Petroleum has spent \(204,000 to refine 61,000 gallons of petroleum distillate, which can be sold for \)6.30 per gallon. Alternatively, Elm can process the distillate further and produce 58,000 gallons of cleaner fluid. The additional processing will cost \(1.80 per gallon of distillate. The cleaner fluid can be sold for \)9.10 per gallon. To sell the cleaner fluid, Elm must pay a sales commission of \(0.10 per gallon and a transportation charge of \)0.16 per gallon.

Requirements

1. Diagram Elm’s decision alternatives, using Exhibit 25-18 as a guide.

2. Identify the sunk cost. Is the sunk cost relevant to Elm’s decision?

3. Should Elm sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.

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.

What is the decision rule for selling a product as is or processing it further?

What is the decision rule concerning products to emphasize when facing a constraint?

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