For many years Futura Company has purchased the starters that it installs in its

Question

For many years Futura Company has purchased the starters that it installs in its standard line of farm tractors. Due to a reduction in output, the company has idle capacity that could be used to produce the starters. The chief engineer has recommended against this move, however, pointing out that the per unit cost to produce the 70,000 starters needed would be greater than the current $9.10 per unit purchase price Total Per Unit $ 4.00 Direct materials Direct labor Supervision Depreciation Variable manufacturing overhead Rent 2.20 1.60 $ 112,000 1.00 70,000 0.70 0.40 $ 28,000 Total product cost $ 9.90 A supervisor would have to be hired to oversee production of the starters. However, the company has sufficient idle tools and machinery so 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 $81,000 per period. Depreciation is due to obsolescence rather than wear and tear. Required: 1. Determine the total relevant cost per unit if starters are made inside the company. (Round your answer to 2 decimal places.) Relevant cost per unit 2. Determine the total relevant cost per unit if starters are purchased from an outside supplier. (Round your answer to 2 decimal places.) Relevant cost per unit

Explanation / Answer

Solution:

Relevant Cost

Relevant Cost is the cost which will be incurred in future and different under each alternative course of action. The following costs are considered as relevant cost:

- Direct material cost

- Direct labor cost

- Variable manufacturing overhead

- Variable Cost of Goods Sold

- Variable selling and administrative expenses

- Fixed Cost which is directly related to the alternative course of action (traceable Fixed Cost).

The above costs are the variable cost which will vary with the production volume. Hence these costs have both the characteristic of relevant cost i.e. it is a future cost and different under each alternative course of action.

Sometimes there are some fixed costs which will directly associated with the production or increase production units and have characteristics of relevant cost. i.e. future cost and different under each alternative course of action.

Irrelevant cost is the costs which do not play any role in decision making. Irrelevant Cost is the SUNK Cost which has already been incurred and does not change whether company accept or reject the order. Hence it is treated as IRRELEVANT COST.

Part 1 --- Relevant Cost Per Unit if starters are made inside the company

$ per unit

Direct materials per unit

$4.00

Direct labor per unit

$2.20

Supervision cost per unit

$1.60

Variable manufacturing overhead per unit

$0.70

Relevant Cost Per Unit

$8.50

Part 2 – Relevant Cost per unit if starters are purchased from an outside supplier

$ per unit

Purchase Price per unit

$9.10

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you

$ per unit

Direct materials per unit

$4.00

Direct labor per unit

$2.20

Supervision cost per unit

$1.60

Variable manufacturing overhead per unit

$0.70

Relevant Cost Per Unit

$8.50

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