Question

Futura Company purchases the 79,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $10.90 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $11.50 as shown below:

	Per Unit			Total
Direct materials	$	5.00
Direct labor		2.50
Supervision		1.90		$	150,100
Depreciation		1.10		$	86,900
Variable manufacturing overhead		0.40
Rent		0.60		$	47,400
Total product cost	$	11.50

If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $150,100) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $80,000 per period. Depreciation is due to obsolescence rather than wear and tear.

Required:

What is the financial advantage (disadvantage) of making the 79,000 starters instead of buying them from an outside supplier?

Answer 1

	MAKE	BUY	Advantage/(Disadvantage) in making
Direct MATERIAL	395,000
Direct LABOR	197,500
Variable manufacturing OH	31,600
Supervisor Salary	150,100
Purchase Cost		861,100
Total Relevant Cost	774,200	861,100	86,900
The financial advantage (disadvantage) of making the 79,000 starters instead of buying them from an outside supplier is $86900
Note: Depreciation is a sunk cost and need not to be considered while deciding. Because due to in-house production, no new asset is required to be purchase.
Note : Rent expense is for overall plant. Rent will remain same whether we will buy or make. So we will not considered rent for our decision making. Rent is also a suck cost.