Question

Maplewood Company must decide whether to make or buy some of its components. The costs of producing 59,600 switches for its generators are as follows. Direct materials $30,396 Variable overhead $47,680 Direct labour 42,912 Fixed overhead 57,216 Instead of making the switches at an average cost of $2.99 ($178,204 ÷ 59,600), the company has an opportunity to buy the switches at $2.79 per unit. If the company purchases the switches, all the variable costs and one-third of the fixed costs will be eliminated.

Prepare an incremental analysis showing whether the company should make or buy the switches. (Round per unit answers to 2 decimal places, e.g. 15.25. If an amount reduces the net income then enter with a negative sign preceding the number e.g. -15,000 or parenthesis, e.g. (15,000).) Per Unit Make Buy Net Income Increase (Decrease) Number of units:

			$		$		$		$

$

$

$

The company should

the components.

Would your answer be different if the released productive capacity will generate additional income of $28,924? If the released capacity can generate additional income of $28,924, then the company should

the components.

Answer 1

A)

Maplewood company wants to decide whether to make or buy its products, the cost information is given as follows:

Variable costs : Direct Material = $ 30396 , Direct Labor = $ 42912 and Variable overhead= $ 47680 ,

Total Variable costs = $ 120988 and Fixed cost = $ 57,216 , and for 59600 units , per unit cost = $ 2.99

Now the company has an opportunity to buy switches at $ 2.79 per unit ,

looking prima facie, the proposal looks good, but while making the evaluation the additional / incremental costs needs to be evaluated and not the total costs, the relevant costs are the variable costs and the fixed cost which can be avoided, if the benefit is there then decision can be made regarding making or buying the product.3

Here the incremental cost will not only $ 2.79 per unit i.e for 59600 units = 59600 * 2.79 = $ 166284 but it will also include the unavoidable fixed costs, here even fixed costs are sunk cost but for overall decision making it is still relevant. Here the fixed cost unavoidable = $ 57216 * 2/3 = $ 38144

Thus total Relevant costs for buying the product = Purchase cost + Unavoidable fixed cost = $ 166284 + $ 38144

Thus total cost if the product is buyed = $ 204428 , for per unit = $ 204428 / 59600 = $ 3.43

So net income will reduce = Existing cost - Cost if Buyed = $ 178204 - $ 204428 = $ ( 26224)

Here the per unit cost for making = $ 3.43 , which will lead to Net income decrease = ($ 26244)

Thus the company should Make the component.

B)

However  if the released productive capacity will generate additional income of $28,924.

Then the relevant cost will be = Buying cost + unavoidable cost - saving from released capacity

Relevant Cost for buying = $ 166284 + 38144 - 28924 = $ 175,504.

So the per unit cost = 175504 / 59600 = $ 2.94 per unit,

So net income will reduce = Existing cost - Cost if Buyed = $ 178204 - $ 175504 = $ 2700.

Thus the company should Buy the component.