Question

Masse Corporation uses part G18 in one of its products. The company's Accounting Department reports the following costs of producing the 14,800 units of the part that are needed every year. Per Unit Direct materials $1.70 Direct labor $2.70 Variable overhead $5.50 Supervisor's salary $6.00 Depreciation of special equipment $7.10 Allocated general overhead $4.20 An outside supplier has offered to make the part and sell it to the company for $21.00 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company. If the outside supplier's offer were accepted, only $20,800 of these allocated general overhead costs would be avoided. In addition, the space used to produce part G18 could be used to make more of one of the company's other products, generating an additional segment margin of $22,000 per year for that product. Required: a. Calculate the effect on the company's total net operating income of buying part G18 from the supplier rather than continuing to make it inside the company. (Input the amount as a positive value. Omit the "$" sign in your response.) Net operating income would be by $ . b. Which alternative should the company choose? Make Buy

Answer 1

a.)

Alternative I
Make
Particulars	Amt. p.u.
Direct Material	1.70
Direct Labour	2.7
Variable overhead	5.50
Supervisor's salary	6.00
Avoidable fixed overhead (20800/14800)	1.41
Total production cost	17.31
Alternative II
Buy
Particulars	Amt. p.u.
Purchase price	21.00
Total cost (if purchased)	21.00
Particulars	Amt. p.u.
Annual production (A)	14800
Excess cost in buying over manufacturing p.u. (B)	3.69
Total excess cost in buying over manufacturing (A*B)	54680
Less:-Additional segment margin from using the equipment	22000
Net Excess cost	32680

The net operating income of the company for the year will reduce by $ 32680 if they purchase the part from outside instead of manufacturing it in house.

b.) The company should choose to manufacture the part in house, since if it is going to purchase the part from outside it has to incur a net excess cost of $ 32680 for the year as compared to if the part has been manufactured in house.