Question

Riggs Company purchases sails and produces sailboats. It currently produces 1,250 sailboats per year, operating at normal capacity, which is about 80% of full capacity. Riggs purchases sails at $263 each, but the company is considering using the excess capacity to manufacture the sails instead. The manufacturing cost per sail would be $93.89 for direct materials, $81.18 for direct labor, and $90 for overhead. The $90 overhead includes $78,400 of annual fixed overhead that is allocated using normal capacity. The president of Riggs has come to you for advice. “It would cost me $265.07 to make the sails,” she says, “but only $263 to buy them. Should I continue buying them, or have I missed something?” Prepare a per unit analysis of the differential costs. (Round answers to 2 decimal places, e.g. 15.75. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Answer 1

Give that, Riggs purchases sails at $263 each
Caluculation of Cost to make a sail
Direct material	$         93.89
Direct Labor	$         81.18
Overheads (refer working note 1)	$         27.28
Cost to make a Sail	$       202.35
Therefore, Riggs company should MAKE the sail, as cost making a sail is less than cost of buying
		Working note 1:
Annual fixed costs that is included in the $90 over head cost	$       78,400
Give that company will use excess capacity to produce the sails
Therefore, it should not be included in the cost to make sail
Cost that should be excluded from the overhead cost $90 will be (78400/1250)	$         62.72
Cost that should be included in Making of Sail (90-62.72)	$         27.28

	Make Sails	But sails	Net Income Increase/(decrease)
Direct material	$         93.89		$                          93.89
Direct Labor	$         81.18		$                          81.18
Overheads	$         27.28		$                          27.28
Purchase price		$ 263.00	$                       (263.00)
Total Unit Cost	$       202.35	$ 263.00	$                         (60.65)