Question

Diehl Corporation manufactures a variety of parts for use in its product. The company has always produced all of the necessary parts for its product, including all of the electronic circuits. The company sells 16,000 units of its product per year. An outside supplier has offered to sell electronic circuits to the company for a cost of $35 per unit. To evaluate this offer, the company has gathered the following information relating to its own cost of producing the electronic circuits internally:

	Per Unit				16,000 Units per Year
Direct materials	$	16		$	256,000
Direct labor		12			192,000
Variable manufacturing overhead		3			48,000
Fixed manufacturing overhead, traceable		3	*		48,000
Fixed manufacturing overhead, allocated		6			96,000
Total cost	$	40		$	640,000

*One-third supervisory salary; two-thirds depreciation of special equipment (no resale value).

Suppose that if the electronic circuits were purchased, the division supervisor position could be eliminated. Fixed manufacturing overhead will be allocated to other products made by the company. Also, the company could use the freed production capacity to launch a new product. The segment margin of the new product would be $160,000 per year. Given this new assumption, how much would be the financial advantage of buying 16,000 electronic circuits from the outside supplier?

Multiple Choice

• $96,000

• $112,000

• $132,000

• $80,000

Answer 1

Solution

Diehl Corporation

Determination of the financial advantage of buying 16,000 electronic circuits from the outside supplier:

The correct option is $112,000

Computations:

Per Unit Cost to Buy = $35

Per Unit Cost to Make -

Direct materials           $16

Direct labor                 $12

Variable MOH                        $3

Traceable Fixed MOH            $1        ($3 x 1/3 = $1)

Opportunity cost         $10

Total per unit cost       $42

Cost to Make $42 is higher than cost to Buy $35 by $7.

Hence, the financial advantage of buying 16,000 electronic circuits from outside supplier = $7 x 16,000 = $112,000

Notes:

1. The one third supervisory salary of traceable fixed manufacturing overhead ($3 x 1/3) is avoided if the company opts to buy the electronic circuit from outside supplier. Hence, $1 is relevant cost.

2. Also, the opportunity cost relates to the segment margin lost if the company opts to Make the circuit instead of not using the freed production capacity to launch a new product. The segment margin lost (opportunity cost) per unit = $160,000/16,000 units = $10