Your Company makes 40,000 units per year of a part it uses in the products it ma

ID: 2456818 • Letter: Y

Question

Your Company makes 40,000 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows:

Direct materials $13.80

Direct labor 18.10

Manufactoring overhead 4.30

Fixed 24.60

unit product cost 60.80

An outside supplier has offered to sell the company all of these parts it needs for $51.80 a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be $268,000 per year.
If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, $17.00 of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the company's remaining products.
Required:
a. How much of the unit product cost of $60.80 is relevant in the decision of whether to make or buy the part?
b. What is the net total dollar advantage (disadvantage) of purchasing the part rather than making it?

Explanation / Answer

Calculation of Relevant unit Product cost :

Direct Material

$ 13.80

Direct Labor

$ 18.10

Variable Manufacturing overhead

$ 4.30

Fixed Manufacturing overhead ( Avoidable ) = 24.60-17 =

$ 7.60

Relevant unit Product cost

$ 43.80

Calculation of net total dollar advantage (disadvantage) of purchasing the part rather than making :

Saving in relevant production cost (40000 units * $43.80)

$ 1,752,000.00

Additional contribution margin

$ 268,000.00

Less: Cost of Purchase (40000 units *$51.80)

$ (2,072,000.00)

Net total dollar disadvantage of purchasing the part rather than making

$ (52,000.00)