Sardi Inc. is considering whether to continue to make a component or to buy it f

Question

Sardi Inc. is considering whether to continue to make a component or to buy it from an outside supplier. The company uses 17,000 of the components each year. The unit product cost of the component according to the company's cost accounting system is given as follows: Direct materials.......................................... $ 8.20 Direct labor................................................ 9.30 Variable manufacturing overhead.............. 1.20 Fixed manufacturing overhead.................. 4.30 Unit product cost....................................... $23.00 Assume that direct labor is a variable cost. Of the fixed manufacturing overhead, 70% is avoidable if the component were bought from the outside supplier. In addition, making the component uses 2 minutes on the machine that is the company's current constraint. If the component were bought, this machine time would be freed up for use on another product that requires 4 minutes on the constraining machine and that has a contribution margin of $7.00 per unit.When deciding whether to make or buy the component, what cost of making the component should be compared to the price of buying the component?

Explanation / Answer

Direct materials 8.20 Direct labor 9.30 Variable manufacturing overhead 1.20 Fixed manufacturing overhead (4.30*0.70) 3.01 Relevant manufacturing cost 21.71 Add Loss of Contribution (7/4*2) 3.50 = 8.2 + 9.3 + 1.2 + 3.01 + 21.71 + 3.50 = 25.21 is the cost to be considered

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