Question

Dentech, Inc., uses 11 units of part RM67 each month in the production of dentistry equipment. The cost of manufacturing one unit of RM67 is the following:

   

Direct material	$	2,000
Material handling (20% of direct-material cost)		400
Direct labor		32,000
Manufacturing overhead (150% of direct labor)		48,000
Total manufacturing cost	$	82,400

   

Material handling represents the direct variable costs of the Receiving Department that are applied to direct materials and purchased components on the basis of their cost. This is a separate charge in addition to manufacturing overhead. Dentech’s annual manufacturing overhead budget is one-third variable and two-thirds fixed. Scott Supply, one of Dentech’s reliable vendors, has offered to supply part number RM67 at a unit price of $53,000.

   

Required:
1.	If Dentech purchases the RM67 units from Scott, the capacity Dentech used to manufacture these parts would be idle. Should Dentech decide to purchase the parts from Scott, the unit cost of RM67 would increase (or decrease) by what amount?

        

2.	Assume Dentech is able to rent out all its idle capacity for $83,000 per month. If Dentech decides to purchase the 11 units from Scott Supply, Dentech’s monthly cost for RM67 would increase (or decrease) by what amount?

    

3.	Assume that Dentech does not wish to commit to a rental agreement but could use its idle capacity to manufacture another product that would contribute $167,000 per month. If Dentech’s management elects to manufacture RM67 in order to maintain quality control, what is the net amount of Dentech’s cost from using the space to manufacture part RM67?

    

Answer 1

• All working forms part of the answer
• Working:

	Per unit	Units	Total Amount ($)
Direct Material	2000	11	22000
Material handling	400	11	4400
Direct labor	32000	11	352000
Variable manufacturing overhead	16000	11	176000
Total Variable cost	50400	11	554400
Fixed manufacturing overhead	32000	11	352000
Total cost	82400	11	906400

It is clear from above analysis that per unit variable cost is $50400. If the offered amount by Vendor is anywhere more than $50400, the offer will not be profitable.

• Requirement 1: If offer accepted.

Fixed cost will continue to occur.

	per unit	Units	Total Amount ($)
Purchase cost	53000	11	583000
Fixed manufacturing overhead	32000	11	352000
Total cost	85000	11	935000

Hence, the per unit cost will INCREASE from $82400 to $85000 per unit if offer is ACCEPTED.

• Requirement 2: If idle capacity is rented out

	per unit	Units	Amount ($)
Purchase cost	53000	11	583000
Purchase cost	32000	11	352000
Total cost	85000	11	935000
(-) Rent from Idle capacity			83000
Net cost	[852000/11] $77454.55	11	852000

Hence, the total cost per unit will DECREASE from $82400 to $77454 per unit if idle capacity is rented out.

• Requirement 3: Idle capacity to produce another product.

The cost of purchasing will be $935000 (as calculated above in Req 1) if offer accepted. The idle capacity will be used to produce another product which will contribute $167000. Hence, net effective cost of accepting the product will be $935000 - $167000 = $ 768,000.

However, if the unit is not purchased but produced, the total cost will be $906,400 as calculated in working above.

Net cost of using the space to manufacture will be cost of producing ‘plus’ contribution lost.