Question

Futura Company purchases the 61,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $12.70 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 $13.40 as shown below: Total Per Unit $ 7.00 Direct materials Direct labor 2.80 Supervision Depreciation Variable manufacturing overhead $103,700 $61,000 1.70 1.00 0.40 0.50 $30,500 Rent $13.40 Total product cost If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $103,700) 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 $86,000 per period. Depreciation is due to obsolescence rather than wear and tear. Required: What is the financial advantage (disadvantage) of making the 61,000 starters instead of buying them from an outside supplier?

Answer 1

Differential analysis

	Make	Buy
Direct material	427000
Direct labor	170800
Supervisor salary	103700
Variable overhead	24400
Purchase (61000*12.7)		774700
Total relevant cost	725900	774700

Financial advantage = 774700-725900 = 48800