Question

Topic: Relevant Costs & Benefits

Taylor Ltd has bids from several suppliers for a control device used in several models of its popular line of lighting fixtures. Taylor made these devices for the past several years and needs 30,000 units for next year’s production requirements.

Wiring Ltd returned the most attractive bid at $3.20 per unit. It would cost Taylor $9,000 to conduct quality control inspections on the purchased control devices.

Taylor’s costs for 25,000 units of control devices made in the current year were:

	Per Unit ($)	Total Costs ($)
Direct materials	1.30	32,500
Direct labour	0.60	15,000
Variable overhead	0.50	12,500
Fixed overhead applied	1.00	25,000
	3.40	85,000

The only direct and avoidable fixed factory overhead is $10,000, the cost of leasing specialised equipment required to make the control device. If the device is purchased, Tyler could return the specialised equipment, void the lease, and use the freed-up space for storage. This could save Tyler $6,000 storage rental cost per year.

However, the plant space used to produce the control device can be leased to one of the companies in the same vicinity for $5,000 per month for 5 months.

Required:

1. Prepare a differential analysis report to decide whether Taylor Ltd should buy the control device from Wiring Ltd to meet next year’s production requirements of 30,000 units.

2. Based on the differential analysis, what would you recommend? Explain briefly. (1 mark)

3. At what level of requirement would Taylor Ltd be indifferent to either option?

Answer 1

1. Differential Analysis:
Total Cost of Manufacturing of 30,000 units
Direct Materials ($ 1.3/Unit)	39,000.00
Direct Labour ($ 0.6/Unit)	18,000.00
Variable OH ($ 0.5/Unit)	15,000.00
Fixed OH	25,000.00
Total	97,000.00
Cost of buying
Buying from Wiring ($ 3.2/Unit)	96,000.00
Unavoidable fixed Costs	15,000.00
($ 25,000 - $ 10,000)
Saving in Rental Costs	-6,000
Rental income	-25000
($5,000 * 5 months)
Total	80,000.00
Differential costs of manufacturing is $ 17,000 (97,000 - 80,000). 2. As calculabted above, Co can save $ 17,000 per year by buying the devices instead of manufacturing. 3. Indifferent Level Extra fixed costs from manufacturing Oppurnity Rental income 25000 Avoidable fixed costs 10000 Avoidable Rental costs 6000 41000 Difference in Variable costs Buy cost/unit 3.2 Manufacture cost/unit (1.3 + 0.6 +0.5) 2.4 0.8 Hence, indifferent point (41,000/0.8) 51250 units