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Written Assignment Unit 4

The document discusses a company considering two options: producing vacuums itself or purchasing already made vacuums to sell. A differential analysis is conducted to analyze the costs and revenues of each option. Option 1 has total costs of $4,275,000 and profit of $3,225,000, while option 2 has total costs of $4,350,000 and profit of $3,150,000. Therefore, option 1 of producing vacuums itself is recommended as it offers a higher profit margin of $75,000 compared to option 2.

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51 views

Written Assignment Unit 4

The document discusses a company considering two options: producing vacuums itself or purchasing already made vacuums to sell. A differential analysis is conducted to analyze the costs and revenues of each option. Option 1 has total costs of $4,275,000 and profit of $3,225,000, while option 2 has total costs of $4,350,000 and profit of $3,150,000. Therefore, option 1 of producing vacuums itself is recommended as it offers a higher profit margin of $75,000 compared to option 2.

Uploaded by

Shar Mie Chiccobyvu
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Written assignment unit 4

Successful decision making needs management to be able to perform differential analysis.

Differential analysis is the process whereby management analyse different costs and benefits

that arise from alternative options (Walther & Skousen, 2009). Costs and revenues in a given

situation differ with action selected.

This a case of a company with two options, producing vacuums or buying already made

vacuums and selling them. Management is seized on what option to take. A differential

analysis is being undertaken to see the route to take. In this case all costs and revenues are

computed for the two scenarios.

The first option is for the company to produce the vacuums themselves and sell them. Below

is the costs and revenue of the first option.

Cost of producing the 50,000 vacuum per annum

Item Total cost per Comment

annum

Direct materials $ 900,000 $75,000 multiplied by 12 since this

cost is per month

Direct labour $1,200,000 $100,000 multiplied by 12 since

this cost is per month

Variable overhead cost $375,000 $7.50 multiplied by 50,000 units

since the cost is per unit

$1,800,000 150% of $1,200,000 (Fixed factory


Fixed overhead
overhead is applied at 150% of
direct labour cost per unit

Total costs $4,275,000

Contribution margin $5,025,000 Revenue less variable costs

Total revenue $7,500,000 $150 multiplied by 50,000 units

Profit $3,225,000

The alternative is that the company purchases already made vacuums and sell them. Below

are the costs and revenues for the option.

Cost of purchasing them

Cost comment

Cost of purchasing them $3,000,000 $60 multiplied by 50,000

Factory overhead 1,350,000 75% of $1,800,000

Total costs $4,350,000 Cost of purchasing vacuums plus the

factory overheads

Total sales $7,500,000 $150 multiplied by 50,000 selling

price multiplied by number of items

Contribution margin $4,500,000 Revenue less variable costs

Profit $3,150,000 Total sales subtract total costs

Comparing the two options, option 1 has a higher profit margin ($3,225,000) than option 2

($3,150,000). The opportunity cost of going for option 2 is $75,000. It is recommended that

the company go for option 1 as it offers higher profit margin as compared to option 2.

Furthermore option 1 has a higher contribution margin than option 2. Contribution margin is

aggregate amount of revenue that is available to cover profits after taking care of the variable

costs (Zoger & Zoger , 2006).


References

Walther, L. M., & Skousen, C. J. (2009). Managerial and cost accounting. Retrieved 02 10,

2022, from

https://library.ku.ac.ke/wp-coontent/downloads/2011/08/Bookboon/Acoounting/

managerial-cost-accounting.pdf

Zoger, K., & Zoger , L. (2006). The role of financial information in decision making process.

Innovative Marketing.

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