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 $35 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				20,000 Units Per Year
Direct materials	$	17		$	340,000
Direct labor		11			220,000
Variable manufacturing overhead		3			60,000
Fixed manufacturing overhead, traceable		3	*		60,000
Fixed manufacturing overhead, allocated		6			120,000
Total cost	$	40		$	800,000

*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 20,000 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 $200,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 20,000 carburetors from the outside supplier?

4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Answer 1

Variable cost varies with number of unit produced or sold so it is always a relevant cost while making decision .Fixed cost remain constant irrespective of number of unit produced or sold unless avoidable or incremental.

Allocated fixed cost will be incurred whether purchased from outside suppliers or internally manufactured thus it is irrelevant .Out of Traceable fixed cost supervisor salaries will be avoided if not manufactured thus it is a relevant cost .Depreciation will be continued to be charged thus irrelevant

Incremental savings
Direct material	340000
Direct labor	220000
Variable overhead	60000
Fixed manufacturing overhead -traceable (60000*1/3)	20000
Total incremental savings	640000
less:cost to purchase (20000*35)	(700000)
Incremental profit /(loss)	(60000)

there is an incremental loss /Financial disadvantage of60000 if purchased ,

2)No,Offer should not be accepted as there is a loss of 60000

3) financial advantage (disadvantage) of buying 20,000 carburetors from the outside supplier =;Loss in (a) + Segment margin of other product

    = -60000+200000

      140000

4)Yes ,offer should be accepted since there is an profit of 140000