Futura Company purchases the 65,000 starters that it installs in its standard li
ID: 2560159 • Letter: F
Question
Futura Company purchases the 65,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $10.40 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 $10.80 as shown below: Per Unit Total Direct materials $ 4.00 Direct labor 2.80 Supervision 1.90 $ 123,500 Depreciation 1.40 $ 91,000 Variable manufacturing overhead 0.60 Rent 0.50 $ 32,500 Total product cost $ 10.80 If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $123,500) 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 $90,000 per period. Depreciation is due to obsolescence rather than wear and tear. Required: What is the financial advantage (disadvantage) of making the 91,000 starters instead of buying them from an outside supplier?
Explanation / Answer
Statement of Comparitive cost for 65,000 starters (standard production):-
Manufacturing Amount/unit Purchase/unit
Total Production cost 10.8 Total Cost = 10.4
(-) Depreciation 1.4 10.4
Relevant cost 9.4
As we can see above, its better to make 65,000 starters instead of buying it from supplier since the cost to make the starters is less than the purchase cost from supplier.
Also, since the standard production is only 65,000 starters, hence we will be able to make only 65,000 starters and the remaining starters i.e. (91,000-65,000) = 26,000 starters will need to be purchase from the supplier.
Note:-
Depreciation cost has not been considered in the above statemet since it is a fixed cost which will continue to occur irrespective of the decision.
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