Q25-7E - Horngren'S Financial And Managerial Accounting

Question

Priscilla Smiley manages a fleet of 250 delivery trucks for Daniels Corporation. Smiley must decide whether the company should outsource the fleet management function. If she outsources to Fleet Management Services (FMS), FMS will be responsible for maintenance and scheduling activities. This alternative would require Smiley to lay off her five employees. However, her own job would be secure; she would be Daniels’s liaison with FMS. If she continues to manage the fleet, she will need fleet management software that costs \(9,500 per year to lease. FMS offers to manage this fleet for an annual fee of \)300,000. Smiley performed the following analysis:

                                                Retain in-house   Outsource to FMS   Difference 

Annual leasing fee for      \(9,500                                                          \)9,500   

Software 

Annual maintenance of

Trucks                                   147,000                                                       147,000

Total annual salaries of

Five laid-off employees    185,000                                                         185,000

Fleet management

Service’s annual fee                                              \(300,000           (300,000)

Total differential cost of 

Outsourcing                        \)341,500                   \(300,000             \)41,500

Requirements

1. Which alternative will maximize Daniels’s short-term operating income? 

2. What qualitative factors should Daniels consider before making a final decision?

Step-by-Step Solution

Answer

Answer

Outsourcing to FMS is the best alternative to Daniels Corporation because it costs less than in-house retaining. 

Step-by-Step Solution Step 1: Meaning of Differential Analysis

Differential analysis is the technique used in the cost accounting branch to analyze the best alternative from the available alternatives. Under this analysis approach, a sunk cost is ignored while making the final decision. 

Step 2: Maximization of short-term operating income

According to the data mentioned above, outsourcing to FMS is the best alternative that will maximize the operating income of Daniels Corporation. Retaining in-house variable costing is $341,500, which is higher than the outsourcing to FMS, i.e., $300,000. 

Step 3: Consideration of qualitative factors

The following qualitative factors should be considered before making the final decision:

• As mentioned in the data, the impact on other employees’ morale should be considered after laying off the five employees.
• The company must consider the factors associated with the control of the maintenance and scheduling activities that may be reduced.
• Most importantly, the company requires to consider the probable increase in the FMS’s service revenue.