PROBLEM 12-23 Make or Buy Decision LO12-3 Silven Industries, which manufactures

Question

PROBLEM 12-23 Make or Buy Decision LO12-3 Silven Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin. After considerable research, a winter products line has been developed. However, Silven's president has decided to introduce only one of the new products for this coming winter. If the prod uct is a success, further expansion in future years will be initiated The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for $8 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the prod- uct. However, a $90,000 charge for fixed manufacturing overhead will be absorbed by the product under the company's absorption costing system. Using the estimated sales and production of 100,000 boxes of Chap-off, the Accounting Department has developed the following manufacturing cost per box: Direct material Direct labor Manufacturing overhead Total cost $3.60 2.00 1.40 $7.00 terna- The costs above relate to making both the lip balm and the tube that contains it. As an tive to making the tubes for Chap-Off, Silven has approached a supplier to discuss the possibility of buying the tubes. The purchase price of the supplier's empty tubes would be $1.35 per box of 24 tubes. If Silven Industries stops making the tubes and buys them from the outside supplier, its direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and its direct materials costs would be reduced by 25% Required: 1. If Silven buys its tubes from the outside supplier, how much of its own Chap-Off manufac- al turing costs per box will it be able to avoid? (Hint: You need to separate the manufacturing overhead of $1.40 per box that is shown above into its variable and fixed components to derive the correct answer.) 2. What is the financial advantage (disadvantage) per box of Chap-Off if Silven buys its tubes 3. What is the financial advantage (disadvantage) in total (not per box) if Silven buys 100.000 from the outside supplier? boxes of tubes from the outside supplier?

Explanation / Answer

Part 1 Calculation of Manufacturing costs avoided if buying offer accepted

Variable manufacturing overhead ($0.5 * 10%)

(working note 1 for calculation is given below)

Working Note 1-

Calculation of variable manufacturing overhead

Part 2 calculation of advantage/disadvantage

Part 3 Calculation of disadvantage for 100000 boxes

Part 4 - Decision

Particulars Cost avoided by purchasing tubes- Direct material cost ($3.6 * 25%) $0.9 Direct labour ($2 * 10%) $0.2

Variable manufacturing overhead ($0.5 * 10%)

(working note 1 for calculation is given below)

$0.05 Total cost avoided $1.15 Note : Fixed overhead are not considered since they will be same if we buy it or make it hence not relevant in decision making.

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