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Access Inc makes electrically driven disability scooters aimed at elderly and/or disabled customers. At present wheels and tyres are bought from external suppliers but all other parts are manufactured in house. The scooters have a strong reputation due mainly to innovative designs, special power units that can be recharged at home and seats that
enable easy access for a wide range of disabilities. Access Inc also sells power units to other firms.
Current monthly costs are as follows.
Seating
Department Power unit Department
$ $
Costs
Direct materials 9,300 4,140
Direct labour 12,600 9,450
Apportioned overheads 26,700 17,200
–––––– ––––––
48,600 30,790
–––––– ––––––
Production level 60 units 90 units
ACCESS INC
Note: The power unit department currently produces 90 units a month – 60 being used in Access’ own scooters, and 30 being sold externally at $376 each. A new order has been won to supply an additional 10 scooters per month. However, the directors are considering how best to meet the additional demand:
• Sufficient capacity exists for the company to increase its monthly production to 70 scooters, except that making an extra 10 seating assemblies would require reallocation of labour and other resources from the power unit to the seating department. This would cut power unit output by 20 units per month.
• The alternative course would be to buy 10 seating assemblies from an outside supplier and fit the 10 power units from the present production of 90 units. The cheapest quote for seating assemblies is $610 per assembly.
(a) Based on the figures given, show whether Access should make or buy the extra seats. Discuss what other factors should be considered before a final decision is taken to make or to buy the extra seats.
(10 marks)
In the answer to this question, the cost of buying in is calculated as : 10*610 = 6100. BUT the cost of buying in will also include the fact that 10 power units will not also be sold out of the 30 for the external buyers, so there is a lost opportunity of 10*376 = 3760. So the total cost of buying in will be = 6100 + 3760 = 9860. But the Kaplan book says something like this ” In either case, 10 external sales of power units will be lost as these are now used internally. You could have included the cost of these lost sales in both of the above calculations. It is quicker to recognize they are a common cash flow and hence not relevant to the decision.”
So I don’t understand what they are saying here. The fact that they have done 20*376 in the make alternative and NOT 10*376 just invalidates the statement they have made. They’ve not ignored the 10*376 in the make alternative and have taken the full 20 power units. So please explain how to deal with this confusion. This 10*376 should be part of the cost of buying in and I don’t understand why it’s overlooked.
Please help!The Kaplan answer is correct (although they have not explained it too well).
If they buy 10 seating assemblies to make 10 more scooters, then they will indeed lose external sales of 10 power units.
If they make an extra 10 scooters themselves then this will mean a total of 70 power units being used in their own scooters. The power unit department produces 90 power units, but making the extra 10 scooters will lose them 20 power units and so the power unit department will only produce 70 power units. So they will be using all of them in their own scooters and will lose external sales of 30 power units.
So…….you can include the loss of 10 external sales in the ‘buy’ option, and also include the loss of 30 external sales in the ‘make’ option.
Or…..you can do what the Kaplan answer has done and ignore losing 10 external sales from both options – so no loss for the ‘buy’ option and a loss of 20 for the ‘make’ option.
Thank you for your explanation. Now, I get if fully! But Kaplan could have phrased the question better by saying that in both cases the 10 power units will be used from the stock of the existing power unit’s production. In F5, I always find that questions are not phrased properly. e.g. look at Jun 2009 question 5.
Anyway, thank a lot for your help!
It is true that sometimes the problem really is in the wording rather than in the arithmetic itself.
However, to be fair, the examiners do try to make the wording clear, and they do have meetings with the markers so that if it becomes clear that the wording has caused problems then they mark that part of the question more easily.
Sir, in this question, if we look at the cost of making seat assemblies,
Additional cost of making seat assemblies- 3650
Cost saved in power department- (3020)
Sales forgone – 7520The above answer is given in the Kaplan exam kit
But instead of looking at sales, shouldn’t we look at lost contribution of 4500 since if there is no sales, then there wont be any variable costs which would be incurred?
The labour and other resources are simply being moved, and so the total labour cost and the total overhead cost will stay the same.
Yes, but what about the sales part?
Should we take sales or contribution?
Because, the power department would lose the contribution that it earned from the external market,
Also if the power departments sales is reduced, so accordingly their variable costs of making the units will also reduce right?
The contribution would be the sales less the variable costs.
However since about and other resources are being moved, they will still be paying for them. So they will not save anything on them.
What they will lose is the sales revenue.
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