Question

Each year, Burnt Company produces 500,000 units of a component used in vehicle stereos.

An outside supplier has offered to supply the part for $1.28.

The unit cost is:

Direct Materials $0.76

Direct Labor 0.25

Variable Overhead 0.14

Fixed Overhead 2.33

Total Unit Cost $3.48

Part A What are the alternatives for Reinhardt Company?

Part B Assume that none of the fixed cost is avoidable. List the relevant cost(s) of internal production and of external purchase.

Part C Which alternative is more cost effective and by how much?

Part D What if $66,100 of fixed overhead is rental of equipment used only in production of the component that can be avoided if the component is purchased? Which alternative is more cost effective and by how much? Explain.

Answer 1

(A) What are the alternatives for Reinhardt Company?

There are two alternatives i.e Purchase(External Purchase) or Manufacture (Internal Production)

(B) Assume that none of the fixed cost is avoidable. List the relevant cost(s) of internal production and of external purchase.

Relevant cost for Internal Production = Direct Material, Direct Labour, Variable O/H

Relevant cost for External Purchase = Purchase cost

(C) Which alternative is more cost effective and by how much?

Total Relevant cost in Internal Production = (0.76 + 0.25 + 0.14) * 500000 units = $575000

Total Relevant cost of External Purchase = 1.28 * 500000 units = $640000

Internal Production is more cost effective by $65000 (640000 – 575000)

(D) What if $66,100 of fixed overhead is rental of equipment used only in production of the component that can be avoided if the component is purchased? Which alternative is more cost effective and by how much?

Total Relevant cost in Internal Production = [(0.76 + 0.25 + 0.14) * 500000 units] = $575000

Total Relevant cost of External Purchase = (1.28 * 500000 units) - 66100 = $573900

External Purchase is more cost effective by $1100 (575000 – 573900)