Han Products manufactures 34,000 units of part S-6 each year for use on its prod

Question

Han Products manufactures 34,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is:

An outside supplier has offered to sell 34,000 units of part S-6 each year to Han Products for $21 per part. If Han Products accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental of $84,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier.

Required:

What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?

Direct materials $ 3.80 Direct labor 11.00 Variable manufacturing overhead 2.20 Fixed manufacturing overhead 6.00 Total cost per part $ 23.00

Explanation / Answer

Firstly we need to calculate the relevant cost per unit of manufacturing part S-6 which is shown as follows:-

Calculation of Relevant Cost (Amounts in $)

As the purchase cost of $21.00 per unit is less than the relevant cost of manufacturing of $21.47, there is a financial advantage of accepting the outside supplier offer which is calculated as follows:-

Financial Advantage = ($21.47 - $21.00)*34,000 units = $15,980

Direct materials 3.80 Direct labor 11.00 Variable manufacturing overhead 2.20 Avoidable Fixed manufacturing overhead ($6.00*1/3) 2.00 Opportunity cost (Benefits of rent lost per unit) ($84,000/34,000 units) 2.47 Total Relevant Cost of manufacturing S-6 part 21.47

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