Question

Companion Computer Company has been purchasing carrying cases for its portable computers at a delivered cost of $68 per unit. The company, which is currently operating below full capacity, charges factory overhead to production at the rate of 40% of direct labor cost . The fully absorbed (absorption-cost based, not variable or ABC) unit costs to produce comparable carrying cases are expected to be as follows:

Direct Materials	$25.00
Direct Labor	32.00
Factory overhead (40% of direct labor)	12.80
Total cost per unit	$69.80

If Companion Computer Company manufactures the carrying cases, fixed factory overhead costs will not increase and variable factory overhead costs associated with the cases are expected to be 15% of the direct labor costs.
Prepare a differential analysis report for the make or buy (outsource) decision. Would you advise making or buying the carrying cases? Include qualitative reasons as well as the calculations. Explain.

Answer 1

Preparation of differential analysis report for the make or buy (outsource) decision by Companion Computer Company is as under:
Option1:
Buy the carrying cases:
It has been given in the question that the company purchases carrying cases for its portable computers at a delivered cost of $68 per unit.
Hence the byuing option will lead to outflow of $68 per unit of carrying case.
Option 2:
Making the carrying cases:
It has been given in the question that the company charges factory overhead to production at the rate of 40% of direct labor cost
Hence the charge of such factory overhead becomes a Fixed Charge which will be there irrespective the carrying cases are produced or bought from outside.
Therefore the charge of factory overhead to the production at the rate of 40% of direct labor cost will not be relevant for our differential analysis report.
Calculation of cost in case the carrying cases are produced within the company:
Particulars	"Amount (in dolars) for Per Unit of Carrying Case "
Direct Material	25
(+) Direct Labor	32
"(+) Variable Factory Overhead (15% of Direct Labour) (15%*32)"	4.8
Total Cost	61.8
Hence the total cost of producing the per unit of carrying case is $61.8
Conclusion:
Since the cost of producing the per unit of carrying case is lower in producing (at $61.8) as calculated in Option 2 than buying it from outside at $68 as calculated in Option 1, hence the company must produce the carrying cases.
Also Qualitative factors such as, inhouse production will reduce the dependency of the company on outside vendors for carrying cases is another reason that supports inhouse production
Also it will help the company to tap the idle operating capacity of the company.