Gilberto Company currently manufactures one of its crucial parts at a cost of $4

Question

Gilberto Company currently manufactures one of its crucial parts at a cost of $4.30 per unit. This cost is based on a normal production rate of 80,000 units per year. Variable costs are $2.80 per unit, fixed costs related to making this part are $80,000 per year, and allocated fixed costs are $40,000 per year. Allocated fixed costs are unavoidable whether the company makes or buys the part. Gilberto is considering buying the part from a supplier for a quoted price of $3.50 per unit guaranteed for a three-year period. Calculate the total incremental cost of making 80,000 units. Incremental costs to make Relevant Amount per Unit Relevant fixed costs Total relevant costs Total incremental cost to make ____________

Explanation / Answer

The question pertains to the decision whether to Make or Buy the the crucial part.

For evaluation of above two options, it is important to note that only relevant costs shall be considered in decision making i.e. irrelevant cost which do not have any impact on the decision shall not be taken into consideration.

Accordingly, the allocated fixed cost of $40,000 per year which do not change either we make or buy shall not be considered in decision making.

Option I: Cost making

$80,00/80,000units

=$1.00

Option II: Cost of Buying

Thus, on comparing the above two options, cost of making ($304,000) is higher than cost of buying ($280,000).

Therefore, Gilberto company should buy the crucial part from the supplier.

Particulars Relevant amount p.u. Relevant F.C. Total Relevant Cost Variable cost $ 2.80 0 $2.80 Fixed Cost 0

$80,00/80,000units

=$1.00

$1.00 Incremental cost of making $3.80 Cost of making 80,000 units $304,000

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