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 23,000 units of its product per year. An outside supplier has offered to sell electronic circuits to the company for a cost of $37 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				23,000 Units per Year
Direct materials	$	16		$	368,000
Direct labor		9			207,000
Variable manufacturing overhead		4			92,000
Fixed manufacturing overhead, traceable		6	*		138,000
Fixed manufacturing overhead, allocated		9			207,000
Total cost	$	44		$	1,012,000

*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 $230,000 per year. Given this new assumption, how much would be the financial advantage of buying 23,000 electronic circuits from the outside supplier?

Answer 1

Based on the information available in the question, we can calculate the financial advantage as follows:-

No.of Units		23000
Particulars	Per Unit	Make	Buy	Net Income Increase (Decrease)
Direct Materials	16	368,000	-	368,000
Direct Labor	9	207,000	-	207,000
Variable Overhead	4	92,000	-	92,000
Fixed manufacturing, traceable	2	46,000		46,000
Purchase price	37		851,000	(851,000)
Incremental revenue			(230,000)	230,000
Total costs		713,000	621,000	92,000

Fixed manufacturing overheads, traceable used in to calculate the Make decision is limited to 2 because supervisor salary (1/3rd of $6) would be incurred if the company chooses to make the product.

The financial advantage of buying the 23,000 electronic circits from the outside suppliers is $92,000 .