Question

Innova uses 1,070 units of the component IMC2 every month to manufacture one of its products. The unit costs incurred to manufacture the component are as follows. Direct materials $57.50 Direct labor 41.49 Overhead 126.50 Total $225.49 Overhead costs include variable material handling costs of $7.05, which are applied to products on the basis of direct material costs. The remainder of the overhead costs are applied on the basis of direct labor dollars and consist of 60% variable costs and 40% fixed costs. A vendor has offered to supply the IMC2 component at a price of $300 per unit. (a) Prepare the incremental analysis for the decision to make or buy IMC2.

Answer 1

Ques 1
		Make IMC2	Buy IMC2	Net Income Increase (Decrease)
	Direct material	57.5	0	57.5
	Direct labor	41.49	0	41.49
	Material handling	7.05	0	7.05
	Variable overhead*	71.67	0	71.67
	Purchase price	0	300	-300
	Total unit cost	177.71	300	-122.29
*Variable overhead = ($126.50 - $7.05) × 60%
The unit should not be purchased from the outside vendor, as the per unit cost would be $122.29 greater than if they made it.
In order for Innova to make an accurate decision, they would have to know the opportunity cost of manufacturing the other product. As determined in (a), purchasing the product from outside would cost $130,850 more (1,070 × $122.29). Innova would have to increase their contribution margin by more than $130,850 through the manufacture of the other product, before it would be economical for them to purchase the IMC2 from the outside vendor.