Question

Make-or-Buy Decision

Fremont Computer Company has been purchasing carrying cases for its portable computers at a purchase price of $61 per unit. The company, which is currently operating below full capacity, charges factory overhead to production at the rate of 41% of direct labor cost. The unit costs to produce comparable carrying cases are expected to be as follows:

Direct materials	$28
Direct labor	20
Factory overhead (41% of direct labor)	8.2
Total cost per unit	$56.2

If Fremont Computer Company manufactures the carrying cases, fixed factory overhead costs will not increase and variable factory overhead costs associated with the cases are expected to be 15% of the direct labor costs.

a. Prepare a differential analysis dated September 30 to determine whether the company should make (Alternative 1) or buy (Alternative 2) the carrying case. If required, round your answers to two decimal places. If an amount is zero, enter zero "0". Use a minus sign to indicate a loss..

Differential Analysis
Make Carrying Case (Alt. 1) or Buy Carrying Case (Alt. 2)
September 30
	Make Carrying Case (Alternative 1)	Buy Carrying Case (Alternative 2)	Differential Effect on Income (Alternative 2)
Sales price	$	$	$
Unit costs:
Purchase price
Direct materials
Direct labor
Variable factory overhead
Fixed factory overhead
Income (Loss)	$	$	$

b. Assuming there were no better alternative uses for the spare capacity, it would ____ to manufacture the carrying cases. Fixed factory overhead is _____ to this decision.

Answer 1

Part (a) - Differential analysis report

Fremont Company

Differential analysis

Make or buy decision

For september 30

Particulars	Make Carrying case (Alternative 1)	Buy Carrying case (Alternative 2)	Differential effect on income (Alternative 2)
Sales Price (Not given in question)
Unit Cost
Purchase price	$0	$61	$61
Direct Material	$28	$0	($28)
Direct Labour	$20	$0	($20)
Variable factory overhead ($20*15%)	$3	$0	($3)
Fixed Factory Overhead	$8.2	$8.2	$0
Income/(Loss)	$59.2	$69.2	$10 (Saving in unit cost if cases are manufactured)

Conclusion - It is better to make the carrying case instead of buying since unit cost of manufacturing carrying case $10 lower than unit cost of buying cases

Part (b) - Assuming there were no better alternative uses for the spare capacity, it would be advisable to manufacture the carrying cases.

Fixed Factory overhead is irrelevant to this decision.