Question

Fair Engineering Company manufactures part QE 767 used in several of its engine models. Monthly production costs for 10,000 units are as follows: Direct materials Direct labor Variable support costs Fixed support costs Total costs $ 80,000 20,000 50,000 40,000 $190,000 It is estimated that 20% of the fixed support costs assigned to part QE767 will no longer be incurred if the company purchases the part from the outside supplier. Fair Engineering Company has the option of purchasing the part from an outside supplier at $16 per unit. Required: a. Which of QE767's production costs are avoidable? b. What is the dollar value of avoidable costs? c. What is the maximum price that Fair Engineering Company should be willing to pay the outside supplier for each unit of part QE767? d. Should Fair Engineering Company outsource part QE767? Why or why not?

Answer 1

Fixed support cost = $40,000

Avoidable fixed support cost = 40,000 x 20%

= $8,000

a. Direct materials, direct labor, variable support costs and 20% fixed support costs are avoidable since these will not be incurred if part QE767 is bought from the outside supplier.

b.

Direct materials	80,000
Direct labor	20,000
Variable support costs	50,000
Fixed support costs	8,000
Total avoidable costs	$158,000

c. Maximum price per unit to be paid outside supplier = Total avoidable costs / Number of units

= 158,000/10,000

= $15.8

d. The company should not outsource QE767 since total cost of buying the part QE767 is higher than the avoidable cost per unit.

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