Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment

Question

Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has always produced all of the necessary parts for its engines, including all of the carburetors. An outside supplier has offered to sell one type of carburetor to Troy Engines, Ltd., for a cost of $30 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally: 19,000 Units Per Year Per Unit Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overhead, allocated Total cost ? 12 228,000 10 190,000 57,000 3* 57,000 6 114,000 34 646,000 One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value) Requirec 1. Assuming the company has no alternative use for the facilities that are now being used to produce the carburetors, what would be the financial advantage (disadvantage) of buying 19,000 carburetors from the outside supplier? 2. Should the outside supplier's offer be accepted? 3. Suppose that if the carburetors were purchased, Troy Engines, Ltd., could use the freed capacity to launch a new product. The segment margin of the new product would be $190,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 19,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier's offer be accepted?

Explanation / Answer

1. Relevant cost for producing the carburettors should be calculated for decision making. For such calculations

Fixed costs should not be taken into consideration because they will continue to occur regardless of type of decision we take.

Relevant costs is:

Supplier's offer=$30

Financial effect of accepting the offer=$4*19000= -$76000

Thus there is financial disadvantage of $76000

2. No the supplier's offer is not beneficial and thus should not be accepted. As it leads to financial disadvantage of $76000.

3. Alternative using the capacity benefit achieved=$190000

Benefit lost= $76000

Net benefit =$114000

4. Yes, now the supplier's offer can be accepted as it leads to financial advantage of $114000.

Do give your feedback!! Happy Learning :)

Particular $ Direct material 12 Direct labour 10 Variable manufacturing overhead 3 Supervisory wages- avoidable fixed cost (1/3*3) 1 Total relevant cost 26

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