In: Accounting
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 $167,000 per month. If Dentech’s management elects to manufacture RM67 in order to maintain quality control, what is the net amount of Dentech’s cost from using the space to manufacture part RM67? |
Per unit |
Units |
Total Amount ($) |
|
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 $50400, the offer will not be profitable.
Fixed cost will continue to occur.
per unit |
Units |
Total Amount ($) |
|
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 $85000 per unit if offer is ACCEPTED.
per unit |
Units |
Amount ($) |
|
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.
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.