Question

Mountain Bikes Unlimited is currently making the heavy-duty gear shifter that it installs on its most popular line of mountain bikes. The company's Accounting Department reports the following costs of making 8,000 shifters each year

                                                                              Per Unit            8,000 Units

                        Direct Materials                         $        6             $ 48,000

                        Direct Labor                                        4                 32,000

                        Variable overhead                                 1                    8,000

                        Supervisor's salary                                3                  24,000

                        Depreciation of Special Equip.              2                  16,000

                        Allocated General Overhead                 5                  40,000

                        Total cost                                          21                168,000

An outside supplier has offered to sell 8,000 shifters a year to Mountain Bikes Unlimited for a price of only $19 each, or a total of $152,000. If supervisor of the gear shifter manufacturing process would not be retained if the company stops making the shifters. The special equipment has no salvage value and that it has no other use except making the heavy-duty gear shifters. The allocated costs are common to all items produced in the factory and would continue unchanged, being reallocated to other products, if the shifters were bought from an outside supplier.

REQUIRED:

a) Should the company stop making the shifters internally and buy them from the outside supplier?    What is the financial advantage (disadvantage) of this decision?

b) What other factors should Mountain Bikes Unlimited consider when making an outsourcing decision?

Answer 1

a)Advantage of making = cost of buying – Avoidable cost of making

= 152,000 – (48000+32000+8000+24000)

= $40,000

Hence, the company should make and not buy

Advantage of $40,000

b)Other factors to be considered are:

1.Quality of products bought from outside

2.Timely delivery by supplier

3.Alternative use of freed up capacity