Question

19. Futura Company purchases the 72,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $10.80 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 $11.40 as shown below:

	Per Unit			Total
Direct materials	$	5.00
Direct labor		2.80
Supervision		1.50		$	108,000
Depreciation		1.10		$	79,200
Variable manufacturing overhead		0.50
Rent		0.50		$	36,000
Total product cost	$	11.40

If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $108,000) 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 $87,000 per period. Depreciation is due to obsolescence rather than wear and tear.

Required:

What is the financial advantage (disadvantage) of making the 72,000 starters instead of buying them from an outside supplier?

Answer 1

Financial advantage of making

$ 72,000.00

Working

Total Cost of Buying	$ 777600.00,0
Total Cost of manufacturing	$ 705600.00,0
Financial advantage of making	$ 72,000.00

.

Differential Analysis
	Make	Buy
Direct material	$ 360,000
Direct labor	$ 201,600
Variable Overheads	$ 36,000
Fixed overhead	$ 108,000
Purchase price		$ 777,600
Total relevant Cost	$ 705,600	$ 777,600

.

Notes

1. Depreciation will not be considered for calculating relevant cost.

2. Supervisor salary is relavant cost even though it’s a fixed cost . Because this cost is avoidable.

3. The Amount of rent would remain the same whichever option is selected so its also a Irrelevant cost.