Question

Stuart Bicycle Manufacturing Company currently produces the handlebars used in manufacturing its bicycles, which are high­quality racing bikes with limited sales. Stuart produces and sells only 7,200 bikes each year. Due to the low volume of activity, Stuart is unable to obtain the economies of scale that larger producers achieve. For example, Stuart could buy the handlebars for $31 each; they cost $34 each to make. The following is a detailed breakdown of current production costs:

Item Unit Cost Total

Unit­level costs

Materials $15 $ 108,000

Labor 9 64,800

Overhead 2 14,400

Allocated facility­level costs 8 57,600

Total $34 $ 244,800

After seeing these figures, Stuart’s president remarked that it would be foolish for the company to continue to produce the handlebars at $34 each when it can buy them for $31 each.

Required

Calculate the total relevant cost. Do you agree with the president’s conclusion?

Answer 1

Allocated facility costs is irrelevant cost because its incur whether to produce handlebars or not.

Total Relevant cost = materials +Labour + overhead

=   $108,000 + 64, 800 + 14,400

= $ 187, 200

No, we will not agree with president's conclusions, as per unit cost is $26 ($15+$9+$2). Allocated facility costs are not Relevant because it will incurred in the boht situations whether to produce or not.