X Company is considering buying a part next year that they currently produce. A
ID: 2452633 • Letter: X
Question
X Company is considering buying a part next year that they currently produce. A company has offered to supply this part for $16.94 per unit. This year's total production costs for 55,000 units were: Of the total overhead costs, $88,000 were fixed, and $70,400 of these fixed overhead costs are unavoidable. If X Company buys the part, the resources that were used for production can be rented out for $70,000. Production next year is expected to increase to 58,300 units. If X Company continues to make the part instead of buying it, it will saveExplanation / Answer
Fixed cost is divided into two parts, one is avoidable that is if production is not done, that cost can be avoided. The other part is unavoidable that is even if production is not done, this part of fixed cost can be avoided. Variable costs are always avoidable as they are done only when production is done.
Variable Cost per unit = (Total Cost - fixed cost)/number of units produced
= ($ 929,500 - $ 88,000)/55,000
= $ 15.30 per unit
Fixed cost which is unavoidable is not considered for calculating fixed cost per unit as they need to be done even when production is not done.
So, relevant fixed cost per unit at present = $ 17,600/55,000
= $ 0.32 per unit
Revised fixed cost per unit at new level of production = $ 17,600/58,300
= $ 0.30 per unit
So, revised total cost per unit = Fixed cost per unit + Variable cost per unit
= $ 0.30+$ 15.30
= $ 15.60 per unit
The company needs to buy the product from the suppliar at $ 16.94 per unit. So, extra total expenses which the company needs to do is as follows:
Extra cost = (Cost per unit payable-revised production cost per unit) X Production units
= ($ 16.94-$ 15.60) X 58,300
= $ 78,122
Savings if the company continues to make the part instead of buying it is calculated as follows:
Savings = Extra cost - Rental revenue
= $ 78,122-$ 70,000
= $ 8,122
So, the company will save $ 8,122 if it continues to produce the part instead of buying it.
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