Question

Knaack Corporation is presently making part R20 that is used in one of its products. A total of 18,000 units of this part are produced and used every year. The company's Accounting Department reports the following costs of producing the part at this level of activity:

Per Unit
Direct materials.................................. $8.00
Direct labor........................................ $2.50
Variable overhead............................... $7.10
Supervisor's salary........................... ...$7.30
Depreciation of special equipment........ $8.20
Allocated general overhead.............. ....$3.60

An outside supplier has offered to produce and sell the part to the company for $27.70 each. If this offer is accepted, the supervisor's salary and all of the variable costs can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company, none of which would be avoided if the part were purchased instead of produced internally.

Should management buy part R20 from the outside supplier rather than to continue making the part? What is the difference is cost between the make or buy options?

Answer 1

Answer:

It is more convenient to continue production.

Explanation:

Giving the following information:

Per Unit

Direct materials.................................. $8.00

Direct labor........................................ $2.50

Variable overhead............................... $7.10

Supervisor's salary........................... ...$7.30

Depreciation of special equipment........ $8.20

Allocated general overhead.............. ....$3.60

An outside supplier has offered to produce and sell the part to the company for $27.70 each.

The supervisor's salary and all of the variable costs can be avoided.

We need to determine if it is more convenient to buy the product or produced it in house.

First, we need to calculate the cost to produce it in house:

We will take into account the relevant costs (costs that changed with each decision).

Variable cost= direct material + direct labor + variable overhead

Variable cost= 8 + 2.5 + 7.1= $17.6

Fixed costs= 7.3

Total relevant cost= 17.6 + 7.3= $24.9

Buy:

Total relevant cost= 27.7

Cost difference= 27.7 - 24.9= $2.8

It is more convenient to continue production.