2. List the relevant cost(s) of internal production and of external purchase — Coed Scents national producer young adult perfumes colognes needs determine would cheaper

Coed Scents, a national producer of young adult perfumes and colognes, needs to determine if it would be cheaper to produce 100,000 bottles of its most popular perfume, Two AM, for sale in its college town shops or to purchase them from an outside supplier for $25 each. Cost information on internal production includes the following:

Total Cost Unit Cost

Direct materials……………………...$2,000,000………………$20.00

Direct labor……………………..............350,000…………………3.50

Variable manufacturing overhead……...150,000…………………1.50

Variable marketing overhead…………..250,000…………………2.50

Fixed plant overhead…………………..300,000………………….3.00

Total……………………...…………$3,050,000………………$30.50

Fixed overhead will continue whether Two AM is produced internally or externally. No additional costs of purchasing will be incurred beyond the purchase price.

Required:

1. What are the alternatives for Coed Scents?

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2. List the relevant cost(s) of internal production and of external purchase.

3. Which alternative is more cost effective and by how much?

4. Now assume that Coed Scents’ internal audit team learned through a special data analytics project that intellectual property theft is a significant threat for outsourced production. The team estimates that if Coed Scents outsources its production, it will need to spend $350,000 to manage intellectual property theft of its Two AM brand by competitors operating in the country where the outsourced production occurs. Which alternative is more cost effective and by how much?

SOLUTION

1. There are two alternatives: make Two AM in-house or purchase it externally.

2. Relevant costs of making Two AM in-house include direct materials, direct labor, and variable overhead (both manufacturing and marketing). Relevant costs of purchasing Two AM externally include the purchase price.

						Alternatives	Alternatives	Alternatives	Alternatives	Alternatives	Differential	Differential	Differential	Differential
						Make	Make		Buy	Buy	Cost to Make	Cost to Make	Cost to Make	Cost to Make
Direct materials…………………….	Direct materials…………………….	Direct materials…………………….	Direct materials…………………….	Direct materials…………………….	$2,000,000	$2,000,000		—	—			$ 2,000,000
Direct labor……………	Direct labor……………	Direct labor……………	Direct labor……………	Direct labor……………	350,000	350,000		—	—			350,000
Variable manufacturing overhead……	Variable manufacturing overhead……	Variable manufacturing overhead……	Variable manufacturing overhead……	Variable manufacturing overhead……	150,000	150,000		—	—			150,000
Variable marketing overhead………	Variable marketing overhead………	Variable marketing overhead………	Variable marketing overhead………	Variable marketing overhead………	250,000	250,000		—	—			250,000
Purchase cost…………………………	Purchase cost…………………………	Purchase cost…………………………	Purchase cost…………………………	Purchase cost…………………………	—	—		$2,500,000	$2,500,000			(2,500,000)
Total relevant cost…………………	Total relevant cost…………………	Total relevant cost…………………	Total relevant cost…………………	Total relevant cost…………………	$2,750,000	$2,750,000		$2,500,000	$2,500,000			$ 250,000

It is cheaper to buy Two AM in-house. This alternative is cheaper by $250,000.

						Alternatives	Alternatives	Alternatives	Alternatives	Alternatives	Alternatives	Alternatives		Differential	Differential	Differential	Differential	Differential
						Make	Make	Make		Buy	Buy	Buy		Cost to Make	Cost to Make	Cost to Make	Cost to Make	Cost to Make
Direct materials…………	Direct materials…………	Direct materials…………	Direct materials…………	$2,000,000	$2,000,000	$2,000,000		—	—	—			$ 2,000,000	$ 2,000,000	$ 2,000,000
Direct labor………………	Direct labor………………	Direct labor………………	Direct labor………………	350,000	350,000	350,000		—	—	—			350,000	350,000	350,000
Variable manufacturing overhead……	Variable manufacturing overhead……	Variable manufacturing overhead……	Variable manufacturing overhead……	150,000	150,000	150,000		—	—	—			150,000	150,000	150,000
Variable marketing overhead…………	Variable marketing overhead…………	Variable marketing overhead…………	Variable marketing overhead…………	250,000	250,000	250,000		—	—	—			250,000	250,000	250,000
Intellectual property theft	Intellectual property theft	Intellectual property theft	Intellectual property theft
management cost……	management cost……	management cost……	management cost……	—	—	—		350,000	350,000	350,000			(350,000)	(350,000)	(350,000)
Purchase cost…………………………	Purchase cost…………………………	Purchase cost…………………………	Purchase cost…………………………	—	—	—		$2,500,000	$2,500,000	$2,500,000			(2,500,000)	(2,500,000)	(2,500,000)
Total relevant cost……	Total relevant cost……	Total relevant cost……	Total relevant cost……	$2,750,000	$2,750,000	$2,750,000		$2,850,000	$2,850,000	$2,850,000			$ (100,000)	$ (100,000)	$ (100,000)

Now it is cheaper to make Two AM in-house. This alternative is cheaper by $100,000.