Question

Somerset Computer Company has been purchasing carrying cases for its portable computers at a purchase price of $62 per unit. The company, which is currently operating below full capacity, charges factory overhead to production at the rate of 45% of direct labor cost. The unit costs to produce comparable carrying cases are expected to be as follows:

Direct materials $8.00
Direct labor 12.00
Factory overhead (40% of direct labor) 4.80
Total cost per unit $24.80

If Somerset Computer Company manufactures the carrying cases, fixed factory overhead costs will not increase and variable factory overhead costs associated with the cases are expected to be 25% of the direct labor costs.

Required:
Prepare a differential analysis dated April 30 to determine whether the company should make (Alternative 1) or buy (Alternative 2) the carrying case.

Answer 1

Somerset Computer Company

Differential Analysis dated April 30:

Make Buy

Alternative 1 Alternative 2 Difference

Variable cost per unit $23.00 $62.00 $39.00

Step-by-step explanation:

a) Data and Calculations:

Purchase price per portable computer carrying case = $62

Unit cost of production:

Direct materials $8.00

Direct labor 12.00

Factory overhead (40% of direct labor) 4.80

Total cost per unit $24.80

Unit cost of production, with overhead broken into fixed and variable:

Direct materials $8.00

Direct labor 12.00

Factory overhead

Fixed overhead 1.80

Variable overhead 3.00

Total cost per unit $24.80

b) With a net gain of $39 per unit, the company should make the unit (Alternative 1) instead of buying it (Alternative 2).