Question

Recher Corporation uses part Q89 in one of its products. The company's Accounting Department reports the following costs of producing the 8,300 units of the part that are needed every year.

	Per Unit
Direct materials	$	7.10
Direct labor	$	4.00
Variable overhead	$	7.90
Supervisor's salary	$	3.00
Depreciation of special equipment	$	2.60
Allocated general overhead	$	1.40

An outside supplier has offered to make the part and sell it to the company for $25.00 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 $2,800 of these allocated general overhead costs would be avoided. In addition, the space used to produce part Q89 could be used to make more of one of the company's other products, generating an additional segment margin of $16,400 per year for that product.

Required:

a. Prepare a report that shows the financial impact of buying part Q89 from the supplier rather than continuing to make it inside the company.

b. Which alternative should the company choose?

Answer 1

a. Statement showing the financial impact of buying part Q89 from the supplier rather than continuing to make it inside the company:

For evaluating the decision to buy, we must consider the relevant cost in manufaturing the part. Here the relevant cost to make will be Direct material, Direct Labor, Variable overhead, Supervisor salary, avoided general overhead and opportunity cost foregone.

Statement showing savings from not manufacturing the part Q89 will be:

Particulars	per unit cost ($)	Total Cost ($)
Direct Material	$7.1	$58,930 (8,300 * $7.1)
Direct Labor	$4	$33,200 (8,300 * $4)
Variable overhead	$7.9	$65,570 (8,300 * $7.9)
Supervisor salary	$3	$24,900 (8,300 * $3)
Avoidable general overhead		$2,800
Opportunity cost i.e space used for manufacturing other product	$16,400
Total Savings		$201,800

Total cost incurred in purchase of part Q89 = 8,300 units * $25 = $207,500

Therefore net savings in buying part Q89 is ($5,700) i.e.($201,800 - $207,500).

b. Since the net savings from buying part Q89 from the supplier is negative i.e ($5,700) the alternative should not be considered.