Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment
ID: 2562550 • Letter: T
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 $36 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally:
*One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).
Required:
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 20,000 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 $200,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 20,000 carburetors from the outside supplier?
4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?
Complete this question by entering your answers in the tabs below.
Required 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 20,000 carburetors from the outside supplier?
Required 2
Should the outside supplier’s offer be accepted?
Required 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 $200,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 20,000 carburetors from the outside supplier?
Fiancial Disadvantage or Advantage?
Required 4
Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?
Per Unit 20,000 UnitsPer Year Direct materials $ 13 $ 260,000 Direct labor 11 220,000 Variable manufacturing overhead 4 80,000 Fixed manufacturing overhead, traceable 6 * 120,000 Fixed manufacturing overhead, allocated 9 180,000 Total cost $ 43 $ 860,000
Explanation / Answer
Solution:
The problem is related to decision making whether make the product in house or buy from outside supplier,.
In this type of problems, we need to identify the Relevant and Irrelevant Cost for decision making and the treatment of fixed overheads.
Relevant costs are the costs relevant for decision making. It is the future cost that will be incurred and different under each alternative course of action. Relevant costs are such as direct material cost, direct labor cost and variable manufacturing overheads. Generally variable costs are considered relevant costs for decision making.
Irrelevant costs are the sunk cost and fixed overheads that will continue to incur in both the action whether company make product in house or buy from outside. Hence these costs considered as irrelevant for decision making.
Traceable fixed overheads are the overheads which would not exist if the unit under evaluation ceased to exist. Hence these are cost saving if the unit would exist. It is RELEVANT Cost.
Common fixed costs support the operations of more than one unit. It will continue to incur whether the unit under evaluation ceased to exist because these will be allocated to other units. Hence it is IRRELEVANT.
Depreciation would not be relevant because it is a notional cost. Hence not considered in decision making.
Now, we are going to answer the question:
Required 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 20,000 carburetors from the outside supplier?
Since the company has no alternative use for the facilities..
Statement of financial advantage or disadvantage of buying 20,000 carburetors from outside supplier
Relevant Cost for 20,000 Units
Advantage or (Disadvantage) of buying from outside supplier
Make
Buy
Direct materials
$260,000
$0
Direct labor
$220,000
$0
Variable manufacturing overhead
$80,000
$0
Fixed Manufacturing Overhead (Supervisory Salaries) (1/3*120,000)
$40,000
$0
Purchase Cost (20,000 Units x $36)
$720,000
Saving in Supervisor Salary if purchase from outside supplier
-$40,000
Total Relevant Cost
$600,000
$680,000
-$80,000
Financial disadvantage = $80,000
Requirement 2 ----- NO, the outside supplier’s offer should not be accepted.
Requirement 3 ---
Evaluation Statement to identify the advantage or disadvantage from purchasing outside
Segment Margin of New Product by using freed capacity, if the carburetors purchased from outside supplier
$200,000
Less: disadvantage of buying 20,000 Units from outside
($80,000)
Net Advantage from purchasing carburetors from outside
$120,000
Requirement 4 --- Yes, with the new assumption the outside supplier’s offer should be ACCEPTED.
Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you
Relevant Cost for 20,000 Units
Advantage or (Disadvantage) of buying from outside supplier
Make
Buy
Direct materials
$260,000
$0
Direct labor
$220,000
$0
Variable manufacturing overhead
$80,000
$0
Fixed Manufacturing Overhead (Supervisory Salaries) (1/3*120,000)
$40,000
$0
Purchase Cost (20,000 Units x $36)
$720,000
Saving in Supervisor Salary if purchase from outside supplier
-$40,000
Total Relevant Cost
$600,000
$680,000
-$80,000
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