Question

Exercise 20-7 Riggs Company purchases sails and produces sailboats. It currently produces 1,200 sailboats per year, operating at normal capacity, which is about 80% of full capacity. Riggs purchases sails at $257 each, but the company is considering using the excess capacity to manufacture the sails instead. The manufacturing cost per sail would be $94.05 for direct materials, $86.30 for direct labor, and $90 for overhead. The $90 overhead includes $78,000 of annual fixed overhead that is allocated using normal capacity. The president of Riggs has come to you for advice. "It would cost me $270.35 to make the sails," she says, "but only $257 to buy them. Should I continue buying them, or have I missed something?" Prepare a per unit analysis of the differential costs. (Round answers to 2 decimal places, e.g. 15.75. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).) Make Sails Buy Sails Net Income Increase (Decrease) Direct material Direct labor Variable overhead Purchase price Total unit cost

Answer 1

Fixed Overhead per unit = $78000 / 1200 = $65 per unit
Variable overhead per unit = $90 - $65 = $25 per unit

	Make Sails	Buy Sails	Net Income Increase (Decrease)
Direct Materials	$             94.05		$          -94.05
Direct Labor	$             86.30		$          -86.30
Variable Overhead	$             25.00		$          -25.00
Purchase price		$         257.00	$         257.00
Total Unit cost	$          205.35	$         257.00	$            51.65

Riggs should make the sails

Effect of rent per unit = $77300 / 1200 = $64.42
Net Purchase cost = $257 - $64.42 = $192.58

Yes, This is because net income will increase by $12.67 per unit