Chapter 12 In-Class Case A company currently makes a product (Product A) that re

Question

Chapter 12 In-Class Case A company currently makes a product (Product A) that requires part #445. The following costs are required to meet the annual need of 100,000 units of part #445 which is produced in 200 batches: Direct materials Direct labor Total manufacturing overhead Total unit cost $ 50 30 20 $100 A supplier has offered to supply the needed part #445 for $17.00 each. If the company accepts the supplier's offer, its direct material costs will decrease by 10%, its direct labor costs will decrease by 25%, and its unit-related overhead will decrease by 30%. In addition, if component #445 is not produced internally, the number of batches required will be reduced by 25%. An analysis of the total manufacturing overhead reveals that unit-related overhead is $10 per unit, batch-related overhead is $1,000 per batch, and facility-sustaining overhead is $800,000. There is no product-sustaining overhead. 1. Should the company accept the supplier's offer? 2. Assume that if the company accepts the offer, it can use the released space to increase the production of the different product. This increased production will increase profits by $200,000. Should the company accept the supplier's offer? Discuss additional factors the company should consider before deciding whether to continue making part #445 this offer or not. 3.

Explanation / Answer

Solution 1:

Since the company will incur $100,000 less in making it in house, Company should reject the offer.

Working Note:

Wherever the Company incurs less amount as cost, that option will be chosen. It should be noted that Facility Sustaining Overhead will continue to be incurred irrespective of production hence are irrelevant for both the options.

Let's calculate the current cost being borne by the company for 100,000 units:

We will eliminate the facility sustain overhead from both the options.

Let's cacluate the tota cost under Buy Option:

- Direct Material cost per unit will be 50 minus 10% = $45 per unit

- New Direct Labor cost would be $30 minus 25% = $22.5 per unit.

- FacilitySustain Overhead will be ignored since are irrelevant cost.

- No of new batches will be 150 and $1000 will be spent per batch as Overhead.

- Extra material will come at the rate of $17 per unit making the total cost as $1,700,000.

Solution 2:

If the Company accepts the offer and receives $200,000 by alternative use of released space it will earn an additional income of $100,000 ($200,000 - $100,000 extra spent in buying). In this case, For Increased Benefit, company can accept the supplier's offer.

Solution-3:

- Company should consider the future price changes if the cost of production becomes high in future. The same can be ensured by fixing the Purchase price in beginning with vendor.

- Company should explore the alternative uses of released space if the company wish to buy the product.

- Company should thoroughly check the quality of material being supplied by Vendor.

100,000 Units 200 Batches Per Unit No of Units Total Direct Material 50 100,000 5,000,000 Direct Labor 30 100,000 3,000,000 Total Manufacturing Overhead 20 100,000 2,000,000 Less: Facility Sustain Overhead -800,000 Total Cost 9,200,000

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