Question

Ardi Inc. is considering whether to continue to make a component or to buy it from an outside supplier. The company uses 13,200 of the components each year. The unit product cost of the component according to the company's cost accounting system is given as follows:

Direct materials $ 9.00
Direct labor 6.00
Variable manufacturing overhead 1.80
Fixed manufacturing overhead 3.80
Unit product cost $ 20.60

Assume that direct labor is a variable cost. Of the fixed manufacturing overhead, 25% is avoidable if the component were bought from the outside supplier. In addition, making the component uses 3 minutes on the machine that is the company's current constraint. If the component were bought, time would be freed up for use on another product that requires 6 minutes on this machine and that has a contribution margin of $5.40 per unit.When deciding whether to make or buy the component, what cost of making the component should be compared to the price of buying the component?

Answer 1

Cost of making the component = 17.75 + 2.7=$20.45

Step-by-step explanation:

The relevant cost of making the decision would be the variable cost of the making plus a portion of the avoidable overhead plus the lost contribution from the alternative use of the machine.

Variable cost = 9 + 6 + 1.80 + 25*3.80 =17.75

Lost contribution = (3/6 × 5.40) = 2.7

Noe only the avoidable portion of the fixed cost is relevant the rest of 75% is irrelevant for the decision.

Cost of making the component = 17.75 + 2.7=20.45

Answer 2

the cost that should be compared to the price of buying the component is $12.35

Step-by-step explanation:

Hint : Consider the Incremental costs and revenues for this decision

Direct materials 9.00

Direct labor 6.00

Variable manufacturing overhead 1.80

Fixed manufacturing overhead (3.80×25%) 0.95

Opportunity (5.40)

Total 12.35

Therefore the cost that should be compared to the price of buying the component is $ 12.35