Exercise 12-10 Make or Buy Decision [LO12-3] Futura Company purchases the 68,000
ID: 2560350 • Letter: E
Question
Exercise 12-10 Make or Buy Decision [LO12-3] Futura Company purchases the 68,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $13.10 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $13.50 as shown below: Per Unit Total Direct materials $ 7.00 Direct labor 2.50 Supervision 1.90 $ 129,200 Depreciation 1.50 $ 102,000 Variable manufacturing overhead 0.60 Rent 0.50 $ 34,000 Total product cost $ 13.50 If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $129,200) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $81,000 per period. Depreciation is due to obsolescence rather than wear and tear.
Explanation / Answer
correction in question:-total unit cost coming to be 14 instead of 13.5 , so accordingly i have answered the questionon the basis of 14.unit cost
Make vs.buy decision
There are two types of cost:
1) relevant cost :-cost which changes as per decision and which occurs because of decision.(considered in costing)
2) irreleavnt cost :- generallyalloacted fixed costand sunk cost covered here, which will occur irrespective of decision.(not considered in costing)
Supervision cost:- is relevant cost because it is because of manufacturing we have to fire a supervisor otherwise we wouldn't have.hence to beconsidered.(relevant)
depreciation:- we are not purchasing any plant specially for manufacturing od starters rather we are using idle one and that to thedep is charged beacuse of obsolescencenot becoz of wear and tear, hencedep is an irrelevant cost for decision of make vs. buy.we shouldn't consider it.This cost will occur irrespective of manufacturing(irrelevant)
rent:- rent is also fixed per period and we are using idle capacity for manufacturing purpose.which will be left idle if we won't manufacture and rent will still be paid $81000 per perio.It ia an allocated fixed unavoidable cost, irrelevant for decision making.(irrelevant)
rest all other costs are relevant.
hence total relevant cost of manufacturing staters =7+2.5+1.90+0.6=$12 per unit
total munfacturing cost :- 12*68000 =$816000
total purchasing cost :- 13.1*68000=$890800
advantage of manufacturing over buying = 890800-816000 =$74800
hence company’s chief engineer is not justified with his decisionof not manufacturing,it is better taht company should manufacture.
Particular unit cost amount direct material 7 direct labour 2.5 supervision 1.9 129200 depreciation 1.5 102000 variable manufacturing overhead 0.6 rent 0.5 34000 Total cost 14.0Related Questions
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