UNIVERSITY OF THE PEOPLE

Written Assignment Unit 4 – BUS 5110

Differential Analysis
23 February 2023

Instructor : Dr. Bhavesh Kumar Rathod

A vacuum manufacturer has prepared the following cost data for manufacturing one
of its engine components based on the annual production of 50,000 units.
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Introduction

The process of making decisions (comparing between alternatives and choosing the
best) is considered one of the basic functions of management, as the management of
companies faces many problems that need to take a decision such as: buying from
outside the facility, or manufacturing internally, determining which products should
be produced, and accepting or rejecting special orders...etc.

A vacuum manufacturer faces an issue related to the production of one of its engine
components, and this requires the manager to make a decision either to manufacture
the engine internally or to outsource the purchase of the product from it. This requires
calculating the total in variable and fixed costs incurred by the firm, its annual sales
revenue, calculating the contribution margin, and determining profits for both
alternatives (making, buying the product) (Gordon, 2022).

Make or Buy Differential Analysis for a vacuum manufacturer

According to (Heisinger & Hoyle, n.d.), we can identify the differential analysis for
making and buying decision:

Alternative 1 (Making the engine components internally)

Since the number of units sold per year is 50,000 units, this makes us calculate all
annual fixed and variable costs.
Variable costs: These include direct materials, direct labor, and variable
manufacturing overheads
Fixed costs include: Fixed manufacturing overheads
Total Annual Cost at
Per Unit
50.000 Units
Variable Production Costs
$18.00
Direct Material ($900.000/50.000) $75.000*12=$900.000
$24.00
Direct Labor ($1.200.000/50.000) 100.000*12=$1.200.000

Manufacturing Overhead $7.50 $7.50*50.000=$375.000

Fixed Manufacturing $36 (150%*$24)*50.000=
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Overhead ($150*$24/100) $1.800.000

Total Production Cost $85.5 $4.275.000
Alternative 2 (Buying the engine components- Third Party)
A third party has offered to make the engines for $60 per unit. Accordingly, we have
to calculate the total production costs by adding total variable costs to total fixed
costs; we should pay attention to the avoidable costs as follows:
Total Annual Cost at 50.000
Per Unit
units
Variable Costs
Cost to make engine $60 $60*50.000=$3.000.000

Direct Material $0 $0
0$ 0$
Direct Labor

Manufacturing Overhead 0$ 0$
Fixed Manufactory $27
Overhead ($1.350.000/50.000) 75%*$1.800.000=$1.350.000
Total Production Cost $87 $4.350.000

Differential Analysis for a vacuum manufacturer

Alternative1 Alternative 2
Differential Alternative 1
(Make (Buy from
Amount is
internally) third party)
$7.500.000
Sales Revenues $750.500.000
($150*50.000)
Cost to buy from $0 $3.000.000 $3.000.000 Lower
(third party) ($60*50.000)
Direct Material $900.000 $0 $900.000 Higher
Direct Labor $1.200.000 $0 $1.200.000 Higher
MOH $375.000 $0 $375.000 Higher
Con Margin $5.025.000 $4.500.000 $525.000 Higher
Fixed MOH Costs $1.800.000 $1.350.000 $450.000 Higher
(Rent, Lease, (75%*1.800.
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Salary) 000)
Total Production $4.275.000 $4.350.000 ($75.000) Lower
Costs
Profit $3.225.000 $3.150.000 $75.000 Higher

We can notice through the differential analysis that it is better off for the manufacturer
to make its engine components without outsourcing, as noted in the table
Thus, the first alternative provides a profit of 75,000, and the costs of the first
alternative 4.275.000 are less than the costs of the second alternative 4.350.000. I
recommend the company to manufacture the engine components internally, because it
will save costs and gain profits by $75.000 (Alternative with highest profit and /or
with lowest costs).

Other factors
It must be taken into account that if the product is manufactured internally, training
opportunities must be provided for employees and workers in order to manage the
manufacturing process, supervision and control. Perhaps this will cost the company
additional costs that make it unable to achieve the required profit.
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References

Gordon, J. (2022). Differential Analysis (Accounting) - Explained

What is Differential Analysis? The business Professor. Retrieved 22 February 2023,
from https://thebusinessprofessor.com/en_US/accounting-taxation-and-reporting-
managerial-amp-financial-accounting-amp-reporting/differential-analysis-accounting-
explained

Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for

Managers. https://2012books.lardbucket.org/books/accounting-for-
managers/index.html