BLUE AND GRAY, INC.

Blue & Gray, Inc. manufactures a line of power and hand tools for industrial and home use that is
marketed under its own name. In addition, the company produces parts and accessories for power tools
that are marketed by a large retail chain under the chain's name. Blue & Gray, Inc., must meet the quality
requirements and delivery schedules as established by the chain.

During 2015, sales of parts and accessories to the chain exceeded $30,000,000. Management of Blue &
Gray believed that sales to the chain contributed significantly to overhead and profit as well as to stable
employment. However, during peak periods of sales, the company purchased parts and accessories from
smaller firms for use in its own product line as well as to complete orders for the chain.

In December 2014, the treasurer, production manager, and purchasing manager sat together to decide
whether to produce or purchase next year’s demand of 36,000 couplings, a part of an electrical device.
They expect that the demand of the device prevails for at least next 5 years. The Blue & Gray cost
accounting system recorded actual material costs. However, product costing of direct labor was at a
standard rate per hour. The treasurer recognized that this use of a standard rate per hour for all
operations resulted in some error in costing individual parts. He believed, however, that the standard
labor rate was accurate enough for practical purposes, since actual labor rates did not vary widely and, in
most instances, parts passed through similar machining operations.

Both fixed and variable overhead were charged to products at the standard rate per direct labor hour. The
current labor rates and the overhead accounts, as they were grouped by the company according to their
fixed or variable characteristics, are shown below.

The production manager, Duncan Gray, stated that Blue & Gray could make the couplings in a continuous
production run at 200 per hour. Furthermore, there was sufficient free machine time that other production
would not be influenced unfavorable by the addition of this order. Only requirement is a pressure
machine. He also informed that an amount of $90,000 investment is needed to setup the pressure
machine. Expected life of the machine would be around 5 years. The material for the couplings, he
reported, would cost $450 per 500 couplings.

The purchasing manager, Elwood Blue, observed that a smaller company would sell the couplings to Blue
& Gray at a price of $1.72 per coupling. Vendor evaluation personnel have given the firm a high rating.
The final decision on what to do is up to Elwood, the purchasing manager.

Direct labor $36.00

Variable overhead $16.00
Plant supervision (above basic budget)
Plant indirect labor (material handling)
Supplies, Engineering, Cost accounting of labor, Heat, light, and power,
Workman's comp. taxes, Health insurance
Employer's Social Security contribution
Fixed overhead $28.00
Administrative expense, Selling expense, Taxes and insurance –
general, Factory superintendent, Plant supervision - basic budget
Repairs and depreciation – building, Equipment depreciation and
obsolescence

Questions:
1. What are the risks there and how would the risks be addressed?
2. What should be the recommendation to get couplings: make or buy? Evaluate and Justify his
decision.