ACTY 7212 Advanced Management Accounting
Advanced Management Accounting 2
Requirement-1
Patterson’s, a manufacturer of number of products, is facing reduction in demand and
now considering outsourcing manufacturing of one of its largest selling products. An evaluation
from the financial view point of this outsourcing decision has been presented below:
The cost of outsourcing the product is given in the statement as shown below:
Material Costs
12.7
Labour Cost
1.8
Overhead Costs
2.7
Other Costs
1.5
Total Cost
18.7
Profit Mark-Up (10%)
1.9
Invoice Price
20.6
Opportunity costs
Loss of contribution margin on old sale due
outsourcing (note-1)
2.1
severance pay
2.5
transportation cost
0.6
Total
5.2
Total cost
25.8
Note-1: As the outsourcing decision would result in 5% decrease in sales price and 15% increase
in sale volume, thus, it would affect the contribution margin of the company as below:
Existing
New (if
outsourced)
Sales
90.2
99.2
Net 10%
increase
Cost of Goods
Sold
74.3
85.4
15% increase
Gross Margin
15.9
13.8
contribution
Advanced Management Accounting 3
lost
2.1
Thus, the total cost of product if it is outsourced will be $25.8 million. This cost is to be
compared with the cost of in house manufacture of the firm, which is presented as below:
Direct material costs
14.3
Direct selling costs (commission 8% of 27
million)
2.2
Advertising allowance
2.0
Savings in overhead costs
2.9
Savings in employee cost on outsourcing
(note-2)
5.6
Total
27.0
3
45,000.0
135,000.0
8
32,000.0
256,000.0
10
50,000.0
500,000.0
128
37,000.0
4,736,000.0
5,627,000.0
5.6
From the above computations, it could be observed that the company in house
manufacturing cost of the product is $27 million as against the cost of outsourcing of $25.8
million. Therefore, the cost of outsourcing is lower and hence the company is advised to go for
outsourcing arrangement.
Advanced Management Accounting 4
Requirement-2
The decision for outsourcing the operations should not only be based on the financial
considerations but it should also take into account the non financial factors (Goehlich, 2009).
The firm should consider the fact that it may be financial beneficial for it to outsource the
manufacturing operations in short run; however, the case may not be the same in the long run.
There are a number of non financial factors such as plant obsolescence, machine breakdowns,
employee retrenchment, and loss of goodwill, loss of customer base, loss of suppliers and loss of
distribution network. These are the crucial factors when considering the firm’s operations from
the longer term perspective (Goehlich, 2009).