Futura Company purchases the 70,000 starters that it installs in its standard li
ID: 2436429 • Letter: F
Question
Futura Company purchases the 70,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $9.10 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $9.60 as shown below:
If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $98,000) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $85,000 per period. Depreciation is due to obsolescence rather than wear and tear.
Required:
What is the financial advantage (disadvantage) of making the 70,000 starters instead of buying them from an outside supplier?
Per Unit Total Direct materials $ 4.00 Direct labor 2.20 Supervision 1.40 $ 98,000 Depreciation 1.10 $ 77,000 Variable manufacturing overhead 0.40 Rent 0.50 $ 35,000 Total product cost $ 9.60Explanation / Answer
Relavent costs are those that can be avoided or eliminated by buying externally.
All the variable costs(direct materials, direct labour, variable manufacturing overhead) and Supervision(as hired to make the starters) are relavent.
Irrelavent costs are those unavoidable costs that will not change regardless of whether the firm makes or buy the item.
Depreciation and rent are irrelavent.
Relavent costs per unit = Direct materials + Direct labour + Supervision + Variable manufacturing overhead.
= 4 + 2.2 + 1.4 + 0.4
= 8
Financial advantage = (9.1 - 8) * 70,000 = 77.000
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