Gilberto Company currently manufactures 60,000 units per year of one of its cruc

Question

Gilberto Company currently manufactures 60,000 units per year of one of its crucial parts. Variable costs are $1.60 per unit, fixed costs related to making this part are $60,000 per year, and allocated fixed costs are $30,000 per year. Allocated fixed costs are unavoidable whether the company makes or buys the part. Gilberto is considering buying the part from a supplier for a quoted price of $2.80 per unit guaranteed for a three-year period.

Calculate the total incremental cost of making 60,000 and buying 60,000 units. Should the company continue to manufacture the part, or should it buy the part from the outside supplier?

Calculate the total incremental cost of making 60,000 units. (Round cost per unit answer to 2 decimal places.)

Calculate the total incremental cost of buying 60,000 units. (Round cost per unit answer to 2 decimal places.)

Should the company continue to manufacture the part, or should it buy the part from the outside supplier?

Explanation / Answer

Points to rememeber while doing incremental analysis or Differerntial analysis:

1. Fixed cost that are unavoidable shall not be considered. Because the company will incur these fixed costs irrespective of a decision the company take.

2. Only those costs that changes with the decisions shall be considered.

Calculation of incremental cost of making 60,000 units:

$96,000

[60,000 units x $1.60]

Calculation of Incremental cost of buying 60,000 units:

$168,000

[60,000 units x $2.80]

Note:

1. Fixed cost other than allocated fixed costs shall be considered. Because if company don't make or manufacture the product , the company will not incur those fixed costs.

2. On the other hand, Allocated fixed costs shall not be considered. Because the company would incur this fixed cost whether the company make the product or buy the product.

Conclusion:

Since the Cost of manufacturig the product is lesser or lower then the buying the same, the company shall make or manufacture the product.

Incremental cost to make Relevant amount per unit Relevant Fixed cost Total relevant costs Variable cost $1.60 -

$96,000

[60,000 units x $1.60]

Fixed cost - $60,000 $60,000 Total Incremental cost to make $156,000

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