Question

Recher Corporation uses part Q89 in one of its products. The company's Accounting Department reports the following costs of producing the 7,400 units of the part that are needed every year. Per Unit $ 8.20 4.60 9.10 Direct materials Direct labor Variable overhead Supervisor's salary Depreciation of special equipment Allocated general overhead 3.50 3.00 1.60 An outside supplier has offered to make the part and sell it to the company for $29.00 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 $2,400 of these allocated general overhead costs would be avoideed. In addition, the space used to produce part Q89 could be used to make more of one of the company's other products, generating an additional segment margin of $15,900 per year for that product Required: a. Prepare a report that shows the financial impact of buying part Q89 from the supplier rather than continuing to make it inside the company b. Which alternative should the company choose? Complete this question by entering your answers in the tabs below.
Recher Corporation uses part Q89 in one of its products. The company's Accounting Department reports the following costs of producing the 7,400 units of the part that are needed every year. Per Unit Direct materials $ 8.20 Direct labor $ 4.60 Variable overhead $ 9.10 Supervisor's salary $ 3.50 Depreciation of special equipment $ 3.00 Allocated general overhead $ 1.60 An outside supplier has offered to make the part and sell it to the company for $29.00 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 $2,400 of these allocated general overhead costs would be avoided. In addition, the space used to produce part Q89 could be used to make more of one of the company's other products, generating an additional segment margin of $15,900 per year for that product. Required: a. Prepare a report that shows the financial impact of buying part Q89 from the supplier rather than continuing to make it inside the company. b. Which alternative should the company choose?

Answer 1

Req. A

Report that shows the financial impact of buying part Q89 from the supplier rather than continuing to make it inside the company can be made as under:

Particulars	Make	Buy
Direct Material	$          60,680
Direct Labor	$          34,040
Variable Overhead	$          67,340
Supervisor's salary	$          25,900
Depreciation of special equipment	$                   -
Allocated general overhead	$            2,400
Outside purchase price	$                   -	$        214,600
Opportunity cost	$          15,900	0
Total Cost	$        206,260	$        214,600

Explanation:

To consider the cost of both the options, only cost which is directly attributable to the option should be considered for making the decision. Here in current case all the variable cost attributable to Make option is considered and fixed cost which is avoidable if we do not choose Make option is considered. Allocated general overheads avoidable if Make option is not chosen is $ 2,400 , is considered to calculate the cost. Depreciation is not considered as it is a sunk cost, machine is already purchased, also there is no salvage value. It should not affect the decision as it does not play any role in increasing or decreasing the cost.

Opportunity cost is the earnings lost if an option is chosen. If Make option is chosen  then additional segment margin of $15,900 per year is lost which becomes opportunity cost for Make option. No opportunity cost is mentioned in question for Buy option.

Per unit cost / price is given which is multiplied by 7400 units to calculate the cost, further formulas pasted below:

Buy 1 Particulars 2 Direct Material 3 Direct Labor 4 Variable Overhead 5 Supervisor's salary 6 Depreciation of special equipment 7 Allocated general overhead 8 Outside purchase price 9 Opportunity cost 10 Total Cost Make =8.2*7400 -4.6*7400 =9.1*7400 =3.5*7400 0 2400 =29*7400 15900 =SUM(B2:39) =SUM(C2:09) !

Req. B

Make alternative is cheaper by $ 8,340 ( $ 214,600 - 206,260)

The total cost of Make alternative is lower by $ 8,340. Therefore the company should Make the product