Question

Kirsten Corporation makes 7,800 units per year of a part called a B345 gasket for use in one of its products. Data concerning the unit production costs of the B345 gasket follow: An outside supplier has offered to make the part and sell it to the company for $21 each. If the 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 $4,700 of these allocated general overhead costs would be avoided. In addition, the space used to produce this part could be used to make more of one of the company's other products, generating an additional segment margin of $14,300 per year for that product Required: Prepare a report that shows the financial impact of buying this part from the supplier rather than continuing to make it inside the company. Which alternative should the company choose?

Answer 1

After calculating the total internal production costs and comparing them with the outsourcing costs plus the segment margin benefits, the company can choose the alternative with the lower total cost.

Step-by-step explanation:

The analysis of whether Kirsten Corporation should continue making B345 gaskets or buy them from an outside supplier involves a comparison of the relevant costs. To determine the financial impact, we will compare the total production costs incurred by the company when producing the gaskets internally versus the costs saved and the additional segment margin gained when buying externally and using the production space for another product.

Internal Production Costs:

• Variable costs (avoidable if outsourced)
• Supervisor's salary (avoidable if outsourced)
• Special equipment depreciation (sunk cost, thus not avoidable)
• Allocated general overhead (mostly fixed, with $4,700 avoidable)

Outsourcing Costs and Savings:

• Cost to purchase from supplier: $21 per unit
• Variable costs and supervisor's salary savings
• Allocated general overhead savings of $4,700
• Additional segment margin of $14,300 from using the space for another product