Question

Ned Flanders Corporation makes 100,000 units per year of a plastic gasket for use in one of its products. Data concerning the unit production costs of the one gasket follow:

Direct materials................................................ $0.15

Direct labor......................................................... 0.10

Variable manufacturing overhead...................... 0.13

Fixed manufacturing overhead........................... 0.24

Total manufacturing cost per unit.................... $0.62

An outside supplier has offered to sell Ned Flanders Corporation all of the gaskets it requires. If Flanders Corporation decided to discontinue making and instead buys the gaskets, 25% of the above fixed manufacturing overhead costs could be avoided.

Required:

Assume Ned Flanders Corporation has no alternative use for the facilities presently devoted to production of the gaskets.

1. What are two considerations other than money that Flanders should think about before making the decision to make the component versus buying the component.
2. If the outside supplier offers to sell the gaskets to Flanders for $0.46 each, should Ned Flanders Corporation accept the offer to buy the gaskets or continue to make them? Fully support your answer using relevant cost analysis.

Answer 1

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Ned Flanders Corporation
Two considerations other than money are-
1. Quality of materials should not be improvised. As it may lead to fall in market share.
1. It should not de motivate workers. Workers should be taken care off properly to avoid strikes and lockouts.
To check whether to buy at $ 0.46 or not we have to check the relevant cost of the product.
Particulars	Per unit	Remarks	Remarks
Direct materials	0.15	Relevant	It is a unit level cost so relevant.
Direct Labor	0.10	Relevant	It is a unit level cost so relevant.
Variable Manufacturing overhead	0.13	Relevant	It is a unit level cost so relevant.
Avoidable Fixed Manufacturing overhead	0.06	Relevant	Total is $ 0.24. But 25% is avoidable . Rest 75% is irrelevant and sunk cost.
Relevant cost per unit
Particulars	Amount $	Note
Direct materials	0.15
Direct Labor	0.10
Variable Manufacturing overhead	0.13
Fixed Manufacturing overhead	0.06
Relevant cost per unit of a product	0.44
Less: Price quoted by vendor	0.46
Loss per unit	(0.02)	A
Number of units	100,000.00	B
Financial disadvantage	(2,000.00)	C=A*B
Right now the relevant cost is $ 0.44 while the vendor is giving the same product at $ 0.46. So there is a loss of $ 0.02 per unit. Hence proposal should not be accepted as company will lose $ 2,000 in total.