Question

Decision Making Problems 1. Rosiek Corporation uses part A55 in one of its products. The company's Accounting Department reports the following costs of producing the 4,000 units of the part that are needed every year. Per Unit $2.80 $6.30 $8.50 $2.60 Direct materials. Direct labor. Variable overhead Supervisor's salary. Depreciation of special equipment. Allocated general overhead. $6.80 $6.10 An outside supplier has offered to make the part and sell it to the company for S32.30 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 $4,000 of these allocated general overhead costs would be avoided. In addition, the space uscd to produce part A55 could be used to make 2,000 additional units of one of the company's other products, B76. B76 has a selling price of $52.00 cach, while the variable costs to manufacture a unit of B76 are $39.00. Required: a. Prepare a report that shows the effect on the company's total net operating income of buying part A55 from the supplier rather than continuing to make it inside the company. b. Which alternative should the company choose?

Answer 1

(a) Effect on Company's Total Net Operating Income.
If the Company Produces Inhouse
Particulars	Units	Per Unit	Amount
Direct Materials	4000	2.8	11200
Direct Labour	4000	6.3	25200
Variable Overhead	4000	8.5	34000
Supervisor's Salary	4000	2.6	10400
Relevant Fixed Cost (Note 2)			4000
Notional Loss of Product B76 (Note 3)			26000
Total Relevant Cost			110800
Cost per unit = 110,800/4000 = $ 27.7
Note:
1. Depreciation of Special Equipment is not relevant as it has no salvage value.
2. Fixed Cost amounting to $ 4000 can be avoided if the product is not produced. Other Allocated General Overhead is not relevant
						3. Product B76 can be produced by using the space for producing A55. Hence profit from the same is relevant. Profit = 2000 x (52.00-39.00) = $26000
If the Company procures from outside
Cost per unit = $ 32.30
If the Company produces inhouse, Company's Additional Profit will be = 4000 x (32.30-27.70) = $18,400
(b) Best Alternative for the Company
As the Cost per unit is less if the company produces inhouse, so the best alternative for Company is to produce inhouse.