Palisades Corporation’s Midwest Division manufactures subassemblies that are used in the corporation’s final products. Lynn Hardt of Midwest’s Profit Planning Department has been assigned the task of determining whether a component, JY–65, should continue to be manufactured by Midwest or purchased from Marley Company, an outside supplier. JY–65 is part of a subassembly manufactured by Midwest.

Marley has submitted a bid to manufacture and supply the 32,000 units of JY–65 that Palisades will need for 20x1 at a unit price of $8.65. Marley has assured Palisades that the units will be delivered according to Palisades’ production specifications and needs. While the contract price of $8.65 is only applicable in 20x1, Marley is interested in entering into a long-term arrangement beyond 20x1.

Hardt has gathered the following information regarding Midwest’s cost to manufacture JY–65 in 20x0. These annual costs will be incurred to manufacture 30,000 units.

Direct material.................................................................................$ 97,500

Direct labor...................................................................................... 60,000

Factory space rental......................................................................... 42,000

Equipment leasing costs..................................................................$ 18,000

Other manufacturing overhead........................................................ 112,500

Total manufacturing costs................................................................$330,000

Hardt has collected the following additional information related to manufacturing JY–65.

• Direct materials used in the production of JY–65 are expected to increase 8 percent in 20x1.

• Midwest’s direct-labor contract calls for a 5 percent increase in 20x1.

• The facilities used to manufacture JY–65 are rented under a month-to-month rental agreement.

Thus, Midwest can withdraw from the rental agreement without any penalty. Midwest will have no need for this space if JY–65 is not manufactured.

• Equipment leasing costs represent special equipment that is used in the manufacture of JY–65. This lease can be terminated by paying the equivalent of one month’s lease payment for each year left on the lease agreement. Midwest has two years left on the lease agreement, through the end of the year 20x2.

• Forty percent of the other manufacturing overhead is considered variable. Variable overhead changes with the number of units produced, and this rate per unit is not expected to change in 20x1. The fixed manufacturing overhead costs are expected to be the same across a relevant range of zero to 50,000 units produced.

Equipment other than the leased equipment can be used in Midwest’s other manufacturing operations.

John Porter, divisional manager of Midwest, stopped by Hardt’s office to voice his concern regarding the outsourcing of JY–65. Porter commented, “I am really concerned about outsourcing JY–65.

I have a son-in-law and a nephew, not to mention a member of our bowling team, who work on JY–65.

They could lose their jobs if we buy that component from Marley. I really would appreciate anything you can do to make sure the cost analysis comes out right to show we should continue making JY–65.

Corporate is not aware of the material increases, and maybe you can leave out some of those fixed costs.

I just think we should continue making JY–65!”

Required:

1. a. Prepare an analysis of relevant costs that shows whether or not the Midwest Division of Palisades Corporation should make JY–65 or purchase it from Marley Company for 20x1.

b. Based solely on the financial results, recommend whether the 32,000 units of JY–65 for 20x1 should be made by Midwest or purchased from Marley.

2. Identify and briefly discuss three qualitative factors that the Midwest Division and Palisades Corporation should consider before agreeing to purchase JY–65 from Marley Company.

3. By referring to the standards of ethical conduct for managerial accountants given in Chapter 1, explain why Lynn Hardt would consider the request of John Porter to be unethical.

(CMA, adapted)