25-4TI - Horngren'S Financial And Managerial Accounting

Question

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?

Step-by-Step Solution

Answer

The company should continue making cakes rather than purchasing them from the outside. 

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. 

 

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.

Other considerable factors

1. Outsourcing of the cakes may lead to the loss of customers if the cakes are not delivered on time.
2. The vendor may 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 the clients of the Grimm Company.