Q19E - Horngren'S Financial And Managerial Accounting

Question

Refer to Exercise E25-18. Cool Systems needs 79,000 optical switches. By outsourcing them, Cool Systems can use its idle facilities to manufacture another product that will contribute $225,000 to operating income.

Requirements 

1. Identify the expected net costs that Cool Systems will incur to acquire 79,000 switches under three alternative plans: make the switches, buy the switches and leave facilities idle, buy the switches and use the idle facilities to make another product. 

2. Which plan makes the best use of Cool System’s facilities? Support your answer.

Step-by-Step Solution

Answer

It is advisable for the company to purchase the switches from outside.

Step 1: Meaning of Outsourcing

In business terms, outsourcing refers to a practice in which an outsider is hired or allowed by a business entity to perform planned or existing business tasks. Outsourcing helps business entities fulfill their needs from the outside rather than making/producing products/services in-house. 

 

Step 2: Computation of total expected net cost

 

 

	Make	Facilities Idle	Make New Product
No. of units required	79,000	79,000	79,000
Variable costs:
Direct material @ $5	395,000
Direct labor @ $3	237,000
Variable overhead @ 6	474,000
Purchase cost @ 15		1,185,000	1,185,000
Expected profit contribution from other products			(225,000)
Total expected net cost	1,106,000	1,185,000	960,000

 

Step 3: Decision

Based on the analysis presented above, the company should purchase the switches from an outsider and devote its idle facility to making another product. 

Making another product will add $225,000 to the company’s operating income and decrease the expected cost of switches.