Question

Richardson Company manufactured 6,000 units of a part that is used in its product L-47 and incurred the following costs:

            Direct materials                                            $ 70,000

            Direct labor                                                      30,000

            Variable manufacturing overhead                   20,000

            Fixed manufacturing overhead                       40,000

                                                                                 $160,000

Bradley, Inc. (an outside firm) has made an offer to sell the same component part to Richardson Company for $24 per unit. In analyzing the Richardson Company’s fixed costs, we see that the fixed manufacturing overhead consists mainly of depreciation on the equipment used to manufacture the part and would not be reduced (cannot be avoided) if the component part was purchased from the outside vendor. If the component part is purchased from the outside vendor, Richardson Company has the opportunity to use the factory equipment to produce another product which is estimated to have a contribution margin of $30,000.

Instructions

Prepare an incremental analysis report for Richardson Company’s management to help them make the best decision.

Answer 1

Incremental analysis

	Make	Buy
Direct material	70000
Direct labor	30000
Variable manufacturing overhead	20000
Opportunity Cost	30000
Purchase cost (6000*24)		144000
Total relevant cost	150000	144000

Company should purchase the part because buy the part increase net operating income by $6000