Question

Han Products manufactures 30,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is:

Direct materials	$	3.60
Direct labor		10.00
Variable manufacturing overhead		2.40
Fixed manufacturing overhead		9.00
Total cost per part	$	25.00

An outside supplier has offered to sell 30,000 units of part S-6 each year to Han Products for $21 per part. If Han Products accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental value of $80,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier.

Required:

What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?

Bed & Bath, a retailing company, has two departments—Hardware and Linens. The company’s most recent monthly contribution format income statement follows:

				Department
	Total			Hardware			Linens
Sales	$	4,000,000		$	3,000,000		$	1,000,000
Variable expenses		1,300,000			900,000			400,000
Contribution margin		2,700,000			2,100,000			600,000
Fixed expenses		2,200,000			1,400,000			800,000
Net operating income (loss)	$	500,000		$	700,000		$	(200,000	)

A study indicates that $340,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 10% decrease in the sales of the Hardware Department.

Required:

What is the financial advantage (disadvantage) of discontinuing the Linens Department?

Answer 1

Solution 1:

Financial Advantage (Disadvantage) of accepting Outside supplier's offer
Particulars	Making Part S-6	Accepting Outsider's Offer to Buy Part S-6	Financial advantage (Disadvantage) of Accepting Outside Supplier's Offer
Purchase Price	$0.00	$6,30,000.00	-$6,30,000.00
Direct material	$1,08,000.00	$0.00	$1,08,000.00
Direct Labor	$3,00,000.00	$0.00	$3,00,000.00
Variable overhead	$72,000.00	$0.00	$72,000.00
Fixed Overhead	$2,70,000.00	$1,80,000.00	$90,000.00
Opportunity cost (Rental Value)	$80,000.00	$0.00	$80,000.00
Total Cost	$8,30,000.00	$8,10,000.00	$20,000.00

Solution 2:

Financial Advantage (Disadvantage) of Discontinuing Linens
Particulars	Continue Linens	Discontinue Linens	Financial Advantage (Disadvantage) of Discontinuing Linens
	Amount	Amount
Revenue	$10,00,000.00	$0.00	-$10,00,000.00
Costs:
Variable Expenses	$4,00,000.00	$0.00	-$4,00,000.00
Fixed Expenses	$8,00,000.00	$3,40,000.00	-$4,60,000.00
Loss of Contribution Margin ($2,100,000*10%)	$0.00	$2,10,000.00	$2,10,000.00
Income / (Loss)	-$2,00,000.00	-$5,50,000.00	-$3,50,000.00

Financial Disadvantage = $350,000