2 Futura Company purchases the 68,000 starters that it installs in its standard

Question

2 Futura Company purchases the 68,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $10.30 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 $10.90 as shown below: Per Unit Total $ 5.00 eBook Direct materials Direct labor Supervision Depreciation Variable manufacturing overhead Rent 2.50 1.60 108,800 1.20 $ 81,600 0.30 0.50 $ 34,0e0 Total product cost $ 10.90 If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $108,800) 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 $89,000 per period. Depreciation is due to obsolescence rather than wear and tear. Required What is the financial advantage (disadvantage) of making the 81,600 starters instead of buying them from an outside supplier?

Explanation / Answer

The relevant cost of manufacturing would be the cost which is avaoidable if the manufacturing is not undertaken.

The relevant cost = $5 + $2.50 + $1.6 + $.30 = $9.40

Note: Since there is no new equipment to be purchased for the manufacturing of starters, depreciation is not a relevant cost. Similar is the case for rent, hence rent is also irrelevant cost for decision making purposes.

Since the cost of manufacturing is $9.40 against the purchase cost of $10.30

The financial advantage of manufacturing = ($10.30 - $9.40) * 81600

= $73440

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