Question

Recher Corporation uses part Q89 in one of its products. The company's Accounting Department reports the following costs of producing the 8,000 units of the part that are needed every year.

	Per Unit
Direct materials	$	8.10
Direct labor	$	4.40
Variable overhead	$	8.60
Supervisor's salary	$	3.20
Depreciation of special equipment	$	2.60
Allocated general overhead	$	1.30

An outside supplier has offered to make the part and sell it to the company for $27.60 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company. If the outside supplier's offer were accepted, only $3,000 of these allocated general overhead costs would be avoided. In addition, the space used to produce part Q89 could be used to make more of one of the company's other products, generating an additional segment margin of $16,000 per year for that product.

Required:

a. Prepare a report that shows the financial impact of buying part Q89 from the supplier rather than continuing to make it inside the company.

b. Which alternative should the company choose?

Answer 1

Solution:-

a. Prepare a report that shows the financial impact of buying part Q89 from the supplier rather than continuing to make it inside the company:-

Statement of make or buy
Particulars	Make	Buy
Outside purchase price (8,000 units @ $27.60 per unit)		220,800
Opportunity cost		(16,000)
Direct materials (8,000 units @ $8.10 per unit)	64,800
Direct labor (8,000 units @ $4.40 per unit)	35,200
Variable overhead (8,000 units @ $8.60 per unit)	68,800
Supervisor’s salary (8,000 units @ $3.20 per unit)	25,600
Depreciation of special equipment (Sunk cost)	Nil
Allocated general overhead (avoidable only)	3,000
Total cost	197,400	204,800

b. Which alternative should the company choose:-

The total cost of the make alternative is lower by $7,400. Thus, net operating income would decline by $7,400 if the offer from the supplier were accepted. Therefore, the company should continue to make the part itself.