I. Hindustan Motors manufactures small engines. The engines are sold to manufacturers who install them in such products as lawn mowers. The company currently manufactures all the parts used in these engines but is considering a proposal from an external supplier who wishes to supply the starter assemblies used in these engines.

The starter assemblies are currently manufactured in Division 3 of Hindustan Motors.

The costs relating to the starter assemblies for the past 12 months were as follows:
Direct materials Rs. 20,00,000
Direct manufacturing labor 15,00,000
Manufacturing overhead 40,00,000
Total 75,00,000
Over the past year, Division 3 manufactured 1,50,000 starter assemblies. The average cost for each starter assembly is Rs 50 (Rs 75,00,000 ÷ 1,50,000).

Further analysis of manufacturing overhead revealed the following information. Of the total manufacturing overhead, only 25% is considered variable. Of the fixed portion, Rs 15,00,000 is an allocation of general overhead that would remain unchanged for the company as a whole if production of the starter assemblies is discontinued. A further Rs 10,00,000 of the fixed overhead is avoidable if production of the starter assemblies is discontinued. The balance of the current fixed overhead, Rs 5,00,000, is the division manager's salary. If production of the starter assemblies is discontinued, the manager of Division 3 will be transferred to Division 2 at the same salary. This move will allow the company to save the Rs 4,00,000 salary that would otherwise be paid to attract an outsider to this position.

Required: 

(1) Bharat Electronics, a reliable supplier, has offered to supply starter-assembly units at Rs 40 per unit Because this price is less than the current average cost of Rs 50 per unit, the vice president of manufacturing is eager to accept this offer. On the basis of financial considerations alone, should the outside offer be accepted? Show your calculations. 

(2) How, if at all, would your response to requirement 1 change if the company could use the vacated plant space for storage and, in so doing, avoid Rs 5,00,000 of outside storage charges currently incurred? Why is this information relevant or irrelevant?

II. Explain and illustrate Level 0 to 3 of Variance Analysis with managerial insights.

Answer rating: 100% (QA)

Part I Hindustan Motors The decision on hand is whether to discontinue production of starter assembl... View the full answer