Question

Part U67 is used in one of Broce Corporation's products. The company's Accounting Department reports the following costs of producing the 14,900 units of the part that are needed every year.Per Unit Direct materials $ 1.80Direct labor $ 2.80Variable overhead $ 5.60Supervisor's salary $ 6.10Depreciation of special equipment $ 7.20Allocated general overhead $ 4.30An outside supplier has offered to make the part and sell it to the company for $22.00 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, 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. If the outside supplier's offer were accepted, only $20,900 of these allocated general overhead costs would be avoided.Required:a. Prepare a report that shows the financial impact of buying part U67 from the supplier rather than continuing to make it inside the company.b. Which alternative should the company choose?Prepare a report that shows the financial impact of buying part U67 from the supplier rather than continuing to make it inside the company.

Answer 1

Answer:

a)

Production costs for part U67:

Direct materials $1.80 x 14,900 units = $26,820

Direct labor $2.80 x 14,900 units = $41,720

Variable overhead $5.60 x 14,900 units = $83,440

Supervisor's salary $6.10 x 14,900 units = $90,890

Depreciation of special equipment $7.20 x 14,900 units = $107,280

Allocated general overhead $4.30 x 14,900 units = $64,070

total production costs = $414,220

cost of purchasing the units from outside supplier:

14,900 units x $22 purchase price = $327,800

unavoidable fixed costs = $107,280 + ($64,070 - $20,900) = $150,450

total costs associated to purchasing units = $478,250

Financial disadvantage of purchasing the part from outside supplier instead of producing it = $414,220 - $478,250 = ($64,030)

b)

the company should continue to produce part U67 since the relevant costs associated to purchasing it from an outside vendor would result in a financial disadvantage for the company.

Answer 2

The firm should make the part of U67 in the company instead of buying it from outside supplier as the cost of buying from outside is high. This will lead to financial disadvantage to the company.

What do you mean by 'Make or Buy Decision?

The decision to make or buy is the act of choosing between producing a product indoors or buying it from an external supplier. Decision-making or purchase decisions, such as exports, are about comparing the costs and benefits of in-house production compared to buying elsewhere.

Calculation of financial impact of buying the part of U67 from outside supplier instead of making it in the company:

Cost of making inside the company are as follows:

$\rm\,Production costs for part U67:\\\\\rm\,Direct \; Materials \ 1.80 \times 14,900 \;units = \ 26,820\\\\Direct \; Labor \; \ 2.80 \times 14,900 \; units = \ 41,720\\\\Variable \; overhead \; \ 5.60 \times 14,900 units = \ 83,440\\\\Supervisor's \; salary \; \ 6.10 x 14,900 \; units = \ 90,890\\\\Depreciation \; of \;special \;Equipment \; \ 7.20 \times 14,900 \;units =\ 107,280$

$\rm\,Allocated \; general \; overhead \; \ 4.30 \times 14,900 \; units = \ 64,070\\\\Total \;Production \;Costs = \ 414,220$

Cost of buying the part of U67 from outside supplier:

$\rm\,Cost = 14,900 \;units \times \,\ 22 \,Purchase \;price \\\\Cost = \ 327,800\\\\Unavoidable \; fixed \;costs = \ 107,280 + (\ 64,070 - \ 20,900) \\\\Unavoidable \; fixed \;costs = \ 150,450\\\\Total \;costs \; associated \; to \; purchasing \;units = \ 478,250 (\ 327,800+\ 150,450)$

Financial disadvantage of purchasing the part from outside supplier instead of producing it = $(\ 414,220 - \ 478,250) = (\ 64,030)$

b) The firm should make the product inside the company, as buying it from outside results in financial disadvantage to the company.

Hence, it can be seen that the relevant cost of buying from outside will result in loss for the company. therefore, it should make the product.

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