For many years Futura Company has purchased the starters that it installs in its
ID: 2587769 • Letter: F
Question
For many years Futura Company has purchased the starters that it installs in its standard line of farm tractors. Due to a reduction in output, the company has idle capacity that could be used to produce the starters. The chief engineer has recommended against this move, however, pointing out that the per unit cost to produce the 55,000 starters needed would be greater than the current $12.20 per unit purchase price:
A supervisor would have to be hired to oversee production of the starters. However, the company has sufficient idle tools and machinery so 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 $85,000 per period. Depreciation is due to obsolescence rather than wear and tear.
Determine the total relevant cost per unit if starters are made inside the company. (Round your answer to 2 decimal places.)
Determine the total relevant cost per unit if starters are purchased from an outside supplier. (Round your answer to 2 decimal places.)
What is the increase or decrease in profits as a result of purchasing the starters from an outside supplier rather than making them inside the company? (Do not round intermediate calculations. Round your answer to the nearest dollar amount.)
For many years Futura Company has purchased the starters that it installs in its standard line of farm tractors. Due to a reduction in output, the company has idle capacity that could be used to produce the starters. The chief engineer has recommended against this move, however, pointing out that the per unit cost to produce the 55,000 starters needed would be greater than the current $12.20 per unit purchase price:
Explanation / Answer
Futura Company
Relevant cost – all the costs that are directly related with the production of a product or the costs that are avoidable or incurred with regard to a specific proposal are relevant costs.
For Futura Company the relevant costs include all the costs directly associated with the production of the starters.
Relevant cost per unit of a starter:
Direct material $6.00
Direct labor $3.00
Supervision $1.60
Variable manufacturing overhead $0.40
Total relevant cost $11.00
Hence, the total relevant cost per unit of producing the starters is $11.00
The cost of purchase of starters, $12.20 per unit is the relevant cost per unit of starters, if the starters are purchased from an outside supplier.
Since, the company has idle capacity, which can be used to produce the starters, no portion of the fixed cost is directly related to production of starters. Hence, no other costs are relevant when the company opts to purchase the starters from an outside supplier.
The relevant cost per unit = $12.20
Cost per unit of making the starters inside the company $11.00 (determined in 1. Above)
Cost per unit when starters are purchased from outside supplier $12.20
Excess cost of purchase $1.20 per starter
Hence, the profits decrease by $66,000 (55,000 x $1.20) if the company purchases 55,000 starters from an outside supplier.
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