Question

University Printers has two service departments (Maintenance and Personnel) and two operating departments (Printing and Developing). Management has decided to allocate maintenance costs on the basis of machine-hours in each department and personnel costs on the basis of labor-hours worked by the employees in each.

The following data appear in the company records for the current period:

	Maintenance			Personnel			Printing			Developing
Machine-hours		—			1,000			1,000			3,000
Labor-hours		500			—			500			2,000
Department direct costs	$	14,000		$	40,000		$	47,700		$	34,500

University Printers estimates that the variable costs in the Personnel Department total $20,000 and in the Maintenance Department variable costs total $9,200. Avoidable fixed costs in the Personnel Department are $6,800.

Required:

If University Printers outsources the Personnel Department functions, what is the maximum it can pay an outside vendor without increasing total costs?

Answer 1

If Personnel department is outsourced : If personnel department is outsourced ,there will be a saving of 26800 .Thus the maximum price to pay for outsourcing is equals to savings earned which is $ 26800 so that total cost remains unaffected.

Maximum amount to pay =$ 26800

Variable cost varies with output therefore if department is not operated ,there will be no variable cost .However fixed cost remains constant irrespective of output therefore it will be incurred whether department is operated or not except in case of avoidable fixed cost which is avoided if department is not operated.

	Operated	Outsourced	Incremental Benefit /(cost)
Variable cost	20000	0	20000
Avoidable fixed cost	6800	0	6800
Unavoidable fixed cost(Balancing figure from total cost)	13200    [40000-20000-6800]	13200	0
Total cost	40000	13200	26800