Question

Futura Company purchases the 70,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $10.90 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 $10.80 as shown below: Direct materials Direct labor Supervision Depreciation Variable manufacturing overhead Rent Total production cost Per Unit Total $ 5.00 2.20 1.50 $ 105,000 1.00 $ 70,000 0.70 0.40 $ 28,000 $10.80 If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $105,000) 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 $89,000 per period. Depreciation is due to obsolescence rather than wear and tear. Required: What is the financial advantage (disadvantage) of making the 70,000 starters instead of buying them from an outside supplier?

Answer 1

Solution

Financial advantage of making

$ 105,000

Working

Differential Analysis
	Make	Buy
Direct material	$ 350,000
Direct labor	$ 154,000
Variable Overheads	$ 49,000
Fixed overhead	$ 105,000
Purchase price		$ 763,000
Total relevant Cost	$ 658,000	$ 763,000

.

Total Cost of Buying	$ 763,000
Total Cost of manufacturing	$ 658,000
Financial advantage of making	$ 105,000

Depreciation cost and rent will be same in both alternatives hence they are excluded from above calculations.