Question

1. Makari Motura parts manufacturers produce various motor parts. The cost structure of a part which production per annum is 90,000 units is as follows:

                                                                                   Sh.

           Materials (per unit)                                   540

           Labour (25% fixed)                                     360

           Expenses:

           Variable (Per unit)                                     180

            Fixed                                                           270

           Total                                                            1,350                                                        

The purchasing manager explores that a supplier is ready to supply the part at Sh. 1080.

Required:

1. Explain whether the part should be purchased and production stopped or not.
2. Show the financial positions in both the situations
3. What would be your advice if the resources producing that part are used to produce a product for which the selling price is Sh. 390 per unit (show your computation)

Answer 1

A. total variable cost is

Materials		Sh 540
Labour	75% of 360	270
Variable expenses		180
Total variable cost per unit		Sh 990
No of units		90000
Total variable cost A		89100000
Total fixed cost per unit	1350-990	360
Total fixed cost B	360*90000	32400000
Total cost A +B		121500000

When provide by supplier @ Sh 1080 the variable cost will change to 1080×90000=97200000 while fixed costs can be saved

Hence total cost in this scenario will be 97200000 which is less than 121500000 as earlier calculated in Above table. Hence the part should purchased and production should be stopped

B. Financial position in both scenarios has been shown above

C. If the same resources are used to produce a product which can be sold at 390 per unit, the variable cost will be further reduced to sh 990 - sh 390 I.e. 600 per unit.

Thus total cost will be 600×90000 I.e. 54000000 plus fixed costs of sh 32400000 so total cost will be sh 86400000.

Since this cost is less than sh 97200000 as calculated for purchase of the part, in this case it will be more profitable to continue the production and not go ahead with purchase of parts.