Question

Dentech, Inc., uses 10 units of part RM67 each month in the production of dentistry equipment. The cost of manufacturing one unit of RM67 is the following Direct material $ 3,500   Material handling (20% of direct-material cost) 700   Direct labor 32,000   Manufacturing overhead (150% of direct labor) 48,000           Total manufacturing cost $ 84,200

Material handling represents the direct variable costs of the Receiving Department that are applied to direct materials and purchased components on the basis of their cost. This is a separate charge in addition to manufacturing overhead. Dentech’s annual manufacturing overhead budget is one-third variable and two-thirds fixed. Scott Supply, one of Dentech’s reliable vendors, has offered to supply part number RM67 at a unit price of $56,000.

   

Required:

1.

If Dentech purchases the RM67 units from Scott, the capacity Dentech used to manufacture these parts would be idle. Should Dentech decide to purchase the parts from Scott, the unit cost of RM67 would increase (or decrease) by what amount? 2. Assume Dentech is able to rent out all its idle capacity for $86,000 per month. If Dentech decides to purchase the 10 units from Scott Supply, Dentech’s monthly cost for RM67 would increase (or decrease) by what amount? 3. Assume that Dentech does not wish to commit to a rental agreement but could use its idle capacity to manufacture another product that would contribute $170,000 per month. If Dentech’s management elects to manufacture RM67 in order to maintain quality control, what is the net amount of Dentech’s cost from using the space to manufacture part RM67?

Answer 1

Solution

Dentech Inc

1. Determination of the increase or decrease in unit cost of RM67 if the company decides to purchase the parts from Scott:

Incremental unit cost if RM67 is purchased from Scott:

Purchase price per unit                                   $56,000

Material handling (20% of material cost)       $11,200

Total cost of purchase                                     $67,200

Incremental unit cost if RM67 is manufactured:

Direct material $3,500

Material handling$700

Direct labor$32,000

Variable manufacturing overhead$16,000

Total cost to manufacture$52,200

Difference in costs –

Purchase cost$67,200

Manufacture cost$52,200

Increase in unit cost if RM67 is purchased = $15,000 per unit

Note: variable manufacturing cost = 1/3 x manufacturing overhead = 48,000 x 1/3 = $16,000

1. Increase in unit cost if Dentech decides to purchase and rents out the idle capacity at $86,000:

Increase in Purchase cost of 10 units = 10 x 15,000 = $150,000

Less: rental income from use of idle space$86,000

Increase in monthly cost $64,000 per month

1. Situation 3 – use of idle capacity to manufacture other product with contribution margin of $170,000 per month:

Contribution loss by not manufacturing another product $170,000

Savings in purchase cost of 10 units of RM67 (10 x 15,000)$150,000

Cost of using limited capacity to manufacture part RM67$20,000