Help Save & Ex Exercise 6-10A Outsourcing decision LO 6-3 Vernon Bicycle Manufac

Question

Help Save & Ex Exercise 6-10A Outsourcing decision LO 6-3 Vernon Bicycle Manufacturing Company currently produces the handlebars used in manufacturing its bicycles, which are racing bikes with limited sales. Vernon produces and sells only 7.200 bikes each year. Due to the low volume of activity, Vemon is unable to obtain the economies of scale that larger producers they cost $36 each to make. The following is a detailed breakdown of current production costs: achieve. For example, Vernon could buy the handlebars for $33 each Unit-level costs $14 Labor Overhead $100, 800 57,600 14,400 Allocated facility-level costs $36 $259,200 After seeing these figures, Vernon's president remarked that it would be foolish for the company to continue to produce the handlebars at $36 each when it can buy them for $33 each. Required Calculate the total relevant cost. Do you agree with the president's conclusion? Total r Do you sgre with Prev 7 of 10Next 8

Explanation / Answer

Vernon Bicycle is manufacturing bikes.

Handlebars can buy @ 33 each from the market.

The production cost is $36 per unit which included Material Labour overhead as 14, 8, and 2 respetively. Further, It also included allcoated expenses of $12 per unit.

Let us first understand what are allocated expenses - these expenses are fixed expenses which are incurred as a whole for multiple departments or multiple products as a whole and then allocated department wise or product wise based on certain cirteria say Sales units or maybe other suitable basis. E.g. Rent of factory premises is incurred as a whole where multiple departments are working and multiple products are manufactured. This rent will be allocate among these deparments or products. If the company discontinue any product the rent will not be impacted. It will still be incurred. the only change will be that the allocation to a single product will get enhanced because there remains less products to absorb the cost of rent after discontinuation of one product.

The above thing applies to the current problem. The allocated expenses in the organization will not be impacted if Vernon discontinue to make Handlebars and start buying from the market. This will still be incurred as a whole and it will be allocated to other products. The only expenses which will be discontinued - Material of $14, Labour of 8 and Overheads of $2, totalling 14+8+2 = $24. Thus, Vernon will save $24 by buying the handlebars from the market. therefore it should not be purchased at all. The allocated expenses became irrelevant in this case.

Hence, the relevant costs are = 14+8+2 = $24 per unit

President's view is wrong in the case the cost Vernon will save $24 instead of $36. SHould not buy at all. Should be manufactured only.

Thanks

Ask if there is any doubts.

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