X Company currently makes a part and is considering buying it next year from a c

Question

X Company currently makes a part and is considering buying it next year from a company that has offered to supply it for $14.93 per unit. This year, total costs to produce 52,000 units were:

Of the overhead costs, $104,000 were fixed, and $68,640 of these fixed overhead costs are unavoidable even if X Company buys the part. Production next year is not expected to change. If X Company continues to make the part instead of buying it, it will save    

Explanation / Answer

Relevant costs of manufacturing are variable costs + Relevant fixed costs

Relevant fixed costs are costs which can be avoided if production is not done. Unavoidable fixed costs are sunk costs and are not part of cost for decision making as they have to be incurred even if production is not done

Relevant variable costs

= Direct materials + Direct labor + Variable overhead

= Direct materials + Direct labor + (Overhead – Fixed overhead)

= $306,800 + $228,800 + ($260,000 - $104,000)

= $ 691,600

Relevant fixed costs

= Total fixed overhead – Unavoidable fixed overhead

= $104,000 - $68,640

= $ 35,360

So, Total relevant costs

= Relevant variable costs + Relevant fixed costs

= $691,600 + $35,360

= $ 726,960

So, Relevant cost per unit

= Total cost per unit / Number of units

= $ 726,960 / 52,000

= $ 13.98 per unit

So, Savings due to production

= (Offer price – Production costs) x Number of units

= ($14.93 - $13.98) x 52,000

= $ 49,400

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