Question

Futura Company purchases the 72,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $12.20 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 $13.00 as shown below: Per Unit Total Direct materials $ 6.00 Direct labor 3.00 Supervision 1.70 $ 122,400 Depreciation 1.10 $ 79,200 Variable manufacturing overhead 0.70 Rent 0.50 $ 36,000 Total product cost $ 13.00 If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $122,400) 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 $82,000 per period. Depreciation is due to obsolescence rather than wear and tear. Required: What is the financial advantage (disadvantage) of making the 72,000 starters instead of buying them from an outside supplier?

Answer 1

Differential analysis

	Make	Buy
Direct material	432000
Direct labor	216000
Supervision	122400
Variable manufacturing overhead	50400
Purchase (72000*12.20)		878400
Total relevant cost	820800	878400

Financial advantage = 878400-820800 = 57600