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 one gasket follow:

Direct Materials: $0.15

Direct Labor: $0.10

Variable Mfg Overhead: $0.13

Fixed Mfg Overhead: $0.24

Total Manufacturing Cost per Unit: $0.62

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

Assume NFC 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 NFC accept the offer to buy the gaskets or continue to make them? Fully support your answer using relevant cost analysis.

Answer 1

Question 1

The two consideration other than money that should be kept in mind before deciding what to do are as follows :-

1. The Company must ensure that the quality of gasket the supplier is providing should be as per the requirements of the company and it should be compatible with the production in which it is used because if there are chances that the gasket is not in proper alignment with the product as the previous manufactured gasket was it should not be wirth buying it from outside market.

2. The Company should also look that the excess capacity available released from Manufacturing gasket could be used in increasing the current production process or doing something more to derive extra benefits from free capacity.

Question 2

Relevant Cost Analysis

Particulars	Manufacture	Purchase
Direct Materials	0	0.15
Direct Labour	0	0.10
Variable Manufacturing Overhead	0	0.13
Fixed Manufacturing Overhead	0	0.06
Purchase Price	0.46	0
Total Cost per Gasket	0.46	0.44

Cost per Unit on Purchasing from Outside Supplier = $ 0.46

Total Relevant Cost in manufacturing the Gasket = $ 0.44

Saving in Manufacturing over Buying = 0.46 - 0.44

Saving in Manufacturing over Buying = $ 0.02

As per Relevant Cost analysis the unavoidable fixed Manufacturing Overhead per Unit is not relevant for decision making as it is a sunk cost and it nounds to occur whether there is production or not.

Unavoidable Fixed Manufacturing Overhead = 25% of Total Fixed Manufacturing Overhead

= 25% of $ 0.24

= $ 0.06

Unavoidable Fixed Overhead of $ 0.06 will be relevant for decision making.

Final Conclusion - NFC should continue to make the Gasket instead of purchasing them from outside.