Problem 7 - Accounting

Question

The Theater Arts Guild of Chicago (TAG-C) employs five people in its Publication Department. These people lay out pages for pamphlets, brochures, and other publications for the TAG-C productions. The pages are delivered to an outside company for printing. The company is considering an outside publication service for the layout work. The outside service is quoting a price of \(\$ 15\) per layout page. The budget for the Publication Department for 2010 is as follows: \begin{tabular}{lr} Salaries & \(\$ 220,000\) \\ Benefits & 35,000 \\ Supplies & 30,000 \\ Office expenses & 25,000 \\ Office depreciation & 30,000 \\ Computer depreciation & 22,000 \\ \hline Total & \(\$ 362,000\) \\ \hline \end{tabular} The department expects to lay out 20,000 pages for 2010 . The computers used by the department have an estimated residual value of \(\$ 7,000\). The Publication Department office space would be used for future administrative needs, if the department's function were purchased from the outside. a. Prepare a differential analysis report, dated December 15,2009 , for the make-or-buy decision, considering the 2010 differential revenues and costs. b. On the basis of your analysis in part (a), should the page layout work be purchased from an outside company? c. What additional considerations might factor into the decision making?

Step-by-Step Solution

Answer

a. Outsourced layout saves $62,000. b. Yes, based on cost alone. c. Consider employee impact, service quality, and space utilization.

Step 1: Identify Costs for In-House Layout

The total costs for in-house layout include Salaries (\( \\( 220,000 \)), Benefits (\( \\) 35,000 \)), Supplies (\( \\( 30,000 \)), Office expenses (\( \\) 25,000 \)), Office depreciation (\( \\( 30,000 \)), and Computer depreciation (\( \\) 22,000 \)). This brings the total to \( \\( 362,000 \). The 20,000 pages cost \( \\) 362,000 \) in-house.

Step 2: Calculate Cost Per Page for In-House Layout

Dividing the total in-house cost by the number of pages gives us the cost per page: \(\\( 362,000 / 20,000 = \\) 18.10 \) per page.

Step 3: Identify Costs for Outsourcing

The outside service quotes \( \\( 15 \) per layout page. For 20,000 pages, the cost will be \( 20,000 \times \\) 15 = \\( 300,000 \). The selling of computers provides \( \\) 7,000 \) and is not used here as TAG-C keeps the computers.

Step 4: Perform Differential Analysis

The differential cost is the cost difference between outsourcing and in-house. The in-house cost is \( \\( 362,000 \), and the outsourcing cost is \( \\) 300,000 \). Thus, the differential cost is \( \\( 362,000 - \\) 300,000 = \$ 62,000 \) savings.

Step 5: Decision-Based on Cost Difference

Since outsourcing saves \( \$ 62,000 \), the company should consider outsourcing based on cost savings alone.

Step 6: Consider Non-Financial Factors

Additional considerations include potential impacts on employee morale, the quality and reliability of the external service, possible changes in operational processes, and future needs of the space that could affect the overall decision. These qualitative factors are important alongside the financial analysis.

Key Concepts

Understanding the Make-or-Buy Decision

In deciding whether to make or buy a product or service, businesses weigh the pros and cons of creating it internally versus purchasing it from an external source.
This is known as the make-or-buy decision. For the Theater Arts Guild of Chicago (TAG-C), the dilemma revolves around whether to continue performing layout work in-house or to outsource it. The key factors in a make-or-buy decision include evaluating the costs, quality, and convenience that each option presents. Companies often consider potential cost savings, resource allocation, and strategic alignment with business goals.

• If buying is cheaper, as evidenced by lower outsourcing costs, it might be a better choice.
• However, if in-house production aligns better with company values or future strategies, making could be preferable.

This decision requires careful analysis as it affects finances, operational workflows, and employee dynamics.

Detailed Cost Estimation

Cost estimation is a vital part of the make-or-buy decision. For TAG-C, it involves estimating the total costs of both in-house production and outsourcing. Calculating these costs accurately ensures a well-informed decision. In-house costs at TAG-C encapsulate salaries, benefits, and office expenses among others, totaling $362,000. This is approximately $18.10 per page.
Conversely, outsourcing costs per page are $15, leading to a total cost of $300,000 for the same output volume. Effective cost estimation involves not just identifying the dollar figures but understanding the broader implications:

• Track direct and indirect costs. Salaries and supplies are direct, while depreciation is indirect.
• Consider hidden costs like training or transition costs when outsourcing.
• Include potential revenue changes, like selling unneeded equipment.

Cost estimates provide a comprehensive financial picture that aids in sound decision-making.

Outsourcing Considerations

Opting to outsource requires careful thought about its broader implications beyond just savings. The key considerations include examining both tangible and intangible factors that outsourcing might entail. Firstly, TAG-C will enjoy lower costs through outsourcing, saving $62,000. Despite financial benefits, other factors can deeply impact the decision:

• Employee Morale: Existing staff may face termination or reassignment, which can affect overall workplace morale.
• Quality: The quality of output must meet or exceed current standards, which can vary based on the service provider.
• Management Time: Less control over processes may necessitate increased oversight to ensure standards are met.
• Future Expansion: Outsourcing may free up valuable resources for other strategic initiatives or require adapting to new operational methods.

Such considerations ensure a well-rounded decision that accounts for more than just monetary outcomes.

Conducting a Thorough Financial Analysis

A comprehensive financial analysis is integral to any make-or-buy decision. It involves evaluating all financial aspects, weighing potential savings against internal resource allocations, and understanding the financial impact on the organization. For TAG-C, such an analysis begins with comparing costs directly tied to each option. Outsourcing yields $300,000 in costs against $362,000 in-house, leading to savings. Beyond direct savings:

• Assess ongoing expenses versus one-time costs, like the potential resale of assets.
• Include opportunity costs: reallocating office space for new uses.
• Evaluate long-term implications: savings can enhance competitive positioning and fund future initiatives.

Financial analysis captures these nuances, ensuring a holistic assessment where TAG-C can fully understand the extent of benefits and trade-offs, aiding in robust decision-making.