Question

Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has always produced all of the necessary parts for its engines, including all of the carburetors. An outside supplier has offered to sell one type of carburetor to Troy Engines, Ltd., for a cost of $30 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally: Per Unit 13,000 Units per Year Direct materials $ 13 $ 169,000 Direct labor 9 117,000 Variable manufacturing overhead 3 39,000 Fixed manufacturing overhead, traceable 3 * 39,000 Fixed manufacturing overhead, allocated 6 78,000 Total cost $ 34 $ 442,000 *One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value). Required: 1. Assuming the company has no alternative use for the facilities that are now being used to produce the carburetors, what would be the financial advantage (disadvantage) of buying 13,000 carburetors from the outside supplier? 2. Should the outside supplier’s offer be accepted? 3. Suppose that if the carburetors were purchased, Troy Engines, Ltd., could use the freed capacity to launch a new product. The segment margin of the new product would be $130,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 13,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Answer 1

1)

	manufacturing	buying	financial advantage(disadvantage)
Direct material	169,000	0	169000
Labor	117,000	0	117000
Variable overhead	39,000	0	39000
fixed overhead traceable **	13000[39,000*1/3]	0	13000
fixed over head allocated	78,000	78000	0
cost of buying	0	$390,000[$30*13000]	(390000)
Total cost	$416,000	$468,000	(26000)

** supervisor salary expense will not incur if carburetors are bought.

also depreciation is sunk cost so it is not relevant in decision making.

fixed cost allocated are constant and will occur even if carburetors are bought from outside suppliers.

Financial disadvantage of buying carburetors is $26000

2. No outside suppliers offer should not be accepted as it results in decrease in net income by $26000.

3.

	manufacturing	buying	financial advantage(disadvantage)
Direct material	169,000	0	169000
Labor	117,000	0	117000
Variable overhead	39,000	0	39000
fixed overhead traceable **	13000[39,000*1/3]	0	13000
fixed over head allocated	78,000	78000	0
opportunity cost	130,000	0	130000
cost of buying	0	$390,000[$30*13000]	(390000)
Total cost	$546,000	$468,000	78000

$130,000 is opportunity cost if carburetors are made.

financial advantage is $78000

4. yes offer should be accepted as it results in increase in net income by cost reduction of $78000