Question

Han Products manufactures 27,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is: Direct materials $ 3.50 Direct labor 10.00 Variable manufacturing overhead 2.50 Fixed manufacturing overhead 12.00 Total cost per part $ 28.00 An outside supplier has offered to sell 27,000 units of part S-6 each year to Han Products for $22 per part. If Han Products accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental of $77,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier. Required: What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?

Answer 1

Differential analysis
	Per Unit Differential Cost		27000 units		Difference
No. of Units (Parts)	Make	Buy	Make	Buy
	Per Unit	Per Unit	Total Cost	Total Cost
a	b	c	d =b*27000	e	f =d-e
Direct Materials	$     3.50	$         -	$          94,500	$                 -	$           94,500
Direct labor	$   10.00	$         -	$        270,000	$                 -	$         270,000
Variable manufacturing overhead	$     2.50	$         -	$          67,500	$                 -	$           67,500
Fixed manufacturing overhead	$   12.00		$        324,000	$     216,000	$         108,000
Purchase costs	$         -	$   22.00	$                   -	$     594,000	$       (594,000)
Variable cost	$   28.00	$   22.00	$        756,000	$     810,000	$         (54,000)
Fixed manufactuiring overhead in case of Buy	=	324000 * 2/3 = $216000
Computation of financial advantage (disadvantage) of accepting the outside supplier’s offer:-
Differential analysis
	Make	Buy	Net Income Increase (Decrease)
a	b	c	d = b-c
Total Cost	$756,000	$810,000	-$54,000
Opportunity Cost (Rental value of space)	$77,000	$0	$77,000
Total	$833,000	$810,000	$23,000
Net financial advantage of accepting the outside supplier’s offer = $23000

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