The Funky Fruit Company is one of the leading suppliers in Spain of fresh fruit to large domestic and foreign suppliers. Apart from the high quality products, the company has distinguished itself by using perfect packaging for fresh fruits, which is a crucial feature for the export market. Products that are exported require the packaging to be extra sturdy. The fibreboard boxes used by the company have a special inner lining made from synthetic materials nicknamed LIQ, that was engineered to slow the loss of water from the product, insulate the materials to keep out the heat and to try and increase the shelf life. The unique packaging is one of the reasons for the company’s popularity with their export customers. In order to boost the sales appeal, the carton covers included multi coloured printing and the company logo.
The company required 30,000 standard size boxes per month or 360,000 each year. The Funky Fruit Company operates a separate packaging department, which is entirely devoted to manufacturing and printing the boxes. Roisin, the general manager had thought about the possibility of outsourcing this activity. She reckons that if a good supplier could be identified the company could save on the packaging costs, while also getting satisfactory service. With this objective in mind, she contacted Perfect Packaging Company (PPC), which specialised in the manufacturing of customised packaging boxes. PPC submitted their quotation with and without the printing work. PPC would be willing to supply the 360,000 boxes per annum for a price of €851,680 and this agreement would be valid for 3 years.
Additionally they would also take on the printing work for €83,500 per annum, based on a volume of 360,000 boxes. They would charge €2.50 per printed box for any quantity above 360,000 boxes per annum. 3 Robin compared this PPC quote with the annual cost of operating the department as shown below. Based on these costs, Roisin thought that they should close the department and outsource. She arranged a meeting with the accountant Charlie and the Printing Department Manager Simon to discuss this further. Roisin discussed the proposal and mentioned that they needed to manage costs to remain competitive in this market. Simon agreed with the overall objective in relation to minimising costs, but had doubts if the outsourcing would be cost effective. “I think you may end up paying a higher cost then at present. You are overlooking some important issues. We recently purchased a fresh consignment of LIQ. We have 15 tonnes costing €19,500, which would be enough for our production for the next 3 years.
We had to buy in bulk due to the lack of reliability of supply in the market. We paid €1,200 per ton and the supplier has subsequently raised their prices to €1,440 for future supplies. If we want to resell this stock of LIQ, because no other firm nearby uses it, we would only realize a fraction of the cost incurred, and after transportation etc., we would only recover €840 a tonne. The accountant Charlie agreed. He also mentioned an issue with machinery. They had machinery of €24,000, which they purchased 2 years ago and they depreciated this over 5 years, when it would it have no residual value. If they were to sell the machine now they would only recover €7,200. Charlie also discussed the possibility of saving rent if they were to close the department. The company currently rents warehouse space outside the factory, at a cost of €7,700 per annum. They could vacate this rented warehouse space and shift the facilities into the area currently occupied by the packaging department, if the packaging department was closed. Simon wanted Charlie to clarify what was included in the administration costs that they had allocated to his department. Charlie replied, “Look we have gone through this before, they are the company’s central administration costs including expenses relating to the director’s office, legal costs, accounting activities.
These costs must be apportioned among all operating departments.” EUR EUR Material Cost 324,000 Direct Labour Cost 237,600 Departmental Overhead – Managers salary 216,000 – Rent 57,600 – Machinery Depreciation 48,000 – Repairs and Maintenance 28,800 – Other departmental costs 33,600 384,000 Administration Costs 129,600 Total Annual Cost 1,075,2004 The final item they discussed was in relation to the current staff working in the department. Robin clarified that if they terminated their service they would pay them a redundancy payment. This would be a one off cost of €3,000 for the two workers employed. As nobody had any other points to discuss at this time, they agreed that they would not separate the making and printing of the boxes. They will either make and print the boxes internally or outsource both. They agreed that Charlie would have another look at the numbers and they would discuss this again later.
Requirements a)
Use relevant costing to analyse the situation for a “Make or Buy” decision for the three-year period. Please include an explanation of why you have or have not included costs. (You can ignore taxes and time value of money). (20 marks)
a) From a financial viewpoint, should the company continue to make the packaging boxes internally or outsource it? Why? (5 marks)
b) Critically discuss other quantitative or qualitative aspects that you believe the Funky Fruit Company should consider before their final decision? (15 marks)
c) Discuss the significance of the company’s decision to outsource or not, in terms of its potential impact on operating leverage. (10 marks) (Total 50 marks
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