X Company currently makes a part and is considering buying it next year from a c

Question

X Company currently makes a part and is considering buying it next year from a company that has offered to supply it for $18.14 per unit. This year, total costs to produce 59,000 units were: Direct materials Direct labor Overhead $401,200 336,300 283,200 Of the overhead costs, $59,000 were fixed, and $35,990 of these fixed overhead costs are unavoidable even if X Company buys the part. Production next year is not expected to change If X Company continues to make the part instead of buying it, it will save

Explanation / Answer

Relevant costs of production are costs which are directly incurred for production of the product. These include variable costs and avoidable fixed costs

Unavoidable fixed costs are sunk costs as they cannot be avoided even if production is not done. So, they do not form part of decision making

Variable overhead

= Total overhead – Fixed overhead

= $283,200 - $59,000

= $224,200

So, Total variable costs

= Direct materials + Direct labor + Variable overhead

= $401,200 + $336,300 + $224,200

= $961,700

Relevant fixed costs = Avoidable fixed costs

= Total fixed costs – Unavoidable fixed costs

= $59,000 - $35,990

= $23,010

So, Total relevant costs for production

= Variable + Fixed

= $961,700 + $23,010

= $984,710

So, Relevant production cost per unit

= Total relevant cost per unit / Number of units produced

= $984,710 / 59,000

= $16.69 per unit

So, Savings due to production in place of buying

= (Buying price – Production cost) x Number of units

=( $18.14 - $16.69) x 59,000

= $85,550

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