Exercise 12-11 Make or Buy Decision [LO12-3 Han Products manufactures 29.000 uni

Question

Exercise 12-11 Make or Buy Decision [LO12-3 Han Products manufactures 29.000 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: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total cost per part $ 3.70 12.00 2.38 9.80 $ 27.00 An outside supplier has offered to sell 29,000 units of part S-6 each year to Han Products for $23 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 $79,000. 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 suppliers offer?

Explanation / Answer

Answer:-

If the 29000 units of parts S-6 are purchase from outside supplier then loss in purchase will be=($23 per unit -$21 per unit)*29000 units =$58000

But product is purchase from outside supplier then Han Products can offer the freed facilities which is used to manufacture part S-6 could be rented to another company at an annual rental of $79000.

Hence net benefit will be =Annual rental amount-Loss in purchase from supplier

                                          =$79000-$58000 =$21000

Hence the financial advantage of accepting the outside supplier’s offer will be $21000.

Explanation:- 1)-In fixed manufacturing overhead, avoidable only 1/3 portion (ie-$9 per unit*1/3= $3 per unit) will be taken for decision making, it is considered as a avoidable cost and relevant for decision making.

2)- Fixed manufacturing overhead 2/3 portion (ie- -$9 per unit*2/3= $6 per unit)are unavoidable fixed cost hence not considered in relevant cost, it is continue to occur whether to manufacture the product or buy the product.

Han Products Statement of Comparative cost Manufaturing Amount Purchase from outside Supplier Amount Per unit $ Per unit $ Direct Material                  3.70 Purchase Cost               23.00 Direct Labor                12.00 Variable manufacturing overhead 2.30 Avoidable Fixed manufacturingOverhead                  3.00 Total Manufaturing cost                21.00 Total Purchase cost               23.00

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