Silven Industries, which manufactures and sells a highly successful line of summ

Question

Silven Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin.

After considerable research, a winter products line has been developed. However, Silven's president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated.



p. 522 The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for $8 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $90,000 charge for fixed manufacturing overhead will be absorbed by the product under the company's absorption costing system.

Using the estimated sales and production of 100,000 boxes of Chap-Off, the Accounting Department has developed the following cost per box:





The costs above include costs for producing both the lip balm and the tube that contains it. As an alternative to making the tubes, Silven has approached a supplier to discuss the possibility of purchasing the tubes for Chap-Off. The purchase price of the empty tubes from the supplier would be $1.35 per box of 24 tubes. If Silven Industries accepts the purchase proposal, direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and direct materials costs would be reduced by 25

Explanation / Answer

(a) Current scenario :- Total Production under Absorption costing = 100,000 boxes Fixed OH charged to 100,000 boxes = $90,000 So Fixed OH per box = $90,000/100,000 = $0.90 per Box. As Total Mfg OH per box is $1.40, remaining ($1.40-$0.90) = $0.50 per box is Var Mfg OH. So Var cost per Box is calualted as below :- Direct material $3.60 Direct labor $2.00 Var Mfg overhead $0.50 ------------------------------- Total Var cost per box $6.10 ..............................Ans (a) b. If the cartridges are purchased from the outside supplier:- direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and direct materials costs would be reduced by 25%. So New Var cost per Box is calualted as below :- Direct material $3.60*0.75 = $2.70 Direct labor $2.00*0.90 = $1.80 Var Mfg overhead $0.50*0.90 = $0.45 ------------------------------------------------ New Var cost per box $4.95 ..............................Ans (b) (c) Fixed costs are sunk costs & will be incurred irrespective of Make or Buy. Thus they are not relevant in decision making. So we see the differential Var cost between Make or buy decision. From a & b, we see that differential var cost = $6.10 - $4.95 = $1.15 Thus by buying the Tube, Savingis only $1.15 while tube buying will cost $1.35. Thus there is a Loss of $1.35-$1.15 = $0.20 per box. SO it is not advisable to Buy the tube option. Better Make the tube ourselves.

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