Question

Outdoor Life manufactures snowboards. The cost of making 2,000 sets of bindings last month was as follows: Direct materials $18,000 Direct Labor 3,000 Variable overhead 3,000 Fixed Overhead 8,000 Total Manufacturing Cost $32,000 Cost per set $16 An outside supplier has offered to supply outdoor Life with the bindings for $14 each including shipping costs to its facility. If Outdoor Life accepts the offer it will be able to avoid $3,000 of fixed overhead. In addition if the offer is accepted Outdoor Life will be able to use the freed up facilities to produce another product that will contribute $3,500 to profit per month. Including the opportunity cost, how much will Outdoor Life save each month by accepting the offer from the outside supplier instead of making the bindings if they will need 2,500 sets of bindings next month? A) $3,000 B) $1,500 C) $2,500 D) $1,000

Please show steps including how to get the fixed cost (that is what I am stuck on) Thanks!

Answer 1

Based on the information available, we can calculate the costs for "Make" function as follows :-

Option 1:- Calculate the cost for "Make" function

Particulars	Make
Direct Materials	18,000
Direct Labor	3,000
Variable Overheads	3,000
Fixed Overheads	8,000
Total costs	32,000

Cost per unit for "Make" function = $32,000/2,000 units = $16 per unit

Option 2:- Calculate the cost for "Buy" function

Cost per unit. = $14

Total cost for buying option = $14 * 2,000 units = $28,000

Incremental costs/revenues involved with this decision :-

Fixed costs involved - $5,000 (Since $3,000 can be avoided by accepting the offer, the company will continue to incur the balance $5,000 as part of its fixed expenses monthly)

Incremental revenues - ($3,500)

Incremental cost involved - $1,500

Total costs involved in "Buy" function = $28,000 + $1,500 = $29,500

Step 3:- Calculate savings of Outdoor Life :-

Cost to Make - $32,000

Cost to buy - $29,500

Savings by accepting the offer - $2,500

Based on the above calculations, Option C is correct:- $2,500

Option A, Option B and Option D are incorrect based on the above calculations as they represent diferrent amounts