Question

Futura Company purchases the 77,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $10.20 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $11.40 as shown below:

Per Unit Total
Direct materials $ 5.00
Direct labor 2.00
Supervision 1.70 $ 130,900
Depreciation 1.40 $ 107,800
Variable manufacturing overhead 0.70
Rent 0.60 $ 46,200
Total product cost $ 11.40


If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $130,900) to oversee production. However, the company has sufficient idle tools and machinery such 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 $89,000 per period. Depreciation is due to obsolescence rather than wear and tear.



Required:

What is the financial advantage (disadvantage) of making the 77,000 starters instead of buying them from an outside supplier?

Answer 1

The financial disadvantage of making the starters internally at Futura Company, as opposed to purchasing them, is $92,400. This figure is derived by calculating both variable and fixed costs of production and comparing them to the cost of purchasing the starters externally.

Step-by-step explanation:

The financial advantage or disadvantage of making the 77,000 starters instead of buying them from an outside supplier must be calculated by comparing the total costs associated with each option.

To calculate the cost of making the starters internally, we must consider both variable and fixed costs.

The variable costs for making the starters are the sum of direct materials, direct labor, and variable

manufacturing overhead, which equals $5.00 + $2.00 + $0.70 = $7.70 per unit.

The fixed costs would include supervision ($130,900), depreciation ($107,800, though we should note this is due to obsolescence and not wear, thus it may not change with production level), and rent ($46,200, part of total $89,000 plant rent that is based on the space utilized).

To find the total cost of producing the starters internally:

• Total variable cost: $7.70 per unit x 77,000 units = $592,900
• Total fixed cost: $130,900 (supervision) + $107,800 (depreciation) + $46,200 (allocated rent) = $284,900

Total internal production cost = $592,900 + $284,900 = $877,800

To find the cost of buying the starters externally:

• Total purchasing cost = $10.20 per unit x 77,000 units = $785,400

The financial disadvantage of making the starters internally instead of buying them is the difference between the internal production cost and the purchasing cost:

Financial disadvantage = $877,800 - $785,400 = $92,400

Thus, it would be more expensive for Futura Company to produce the starters internally by $92,400.