Question

Current-Control Inc. manufactures a variety of electrical switches. The company is currently manufacturing all of its own component parts. An outside supplier has offered to sell a switch to Current-Control for $32 per unit. To evaluate this offer, Current-Control has gathered the following information relating to its own cost of producing the switch internally:

	Per Unit	12,000 Units per Year
Direct materials	$ 12	$144,000
Direct labour	10	120,000
Variable manufacturing overhead	3	36,000
Fixed manufacturing overhead, traceable	8*	96,000
Fixed manufacturing overhead, common, but allocated	16	192,000
Total cost	$ 49	$588,000
*25% supervisory salaries; 75% depreciation of special equipment (no resale value)

Required:

1. Assuming that the company has no alternative use for the facilities now being used to produce the switch, should the outside supplier’s offer be accepted? Show all computations.

2. Suppose that if the switches were purchased, Current-Control could use the freed capacity to launch a new product. The segment margin of the new product would be $78,000 per year. Should Current-Control accept the offer to buy the switches from the outside supplier for $32 each? Show computations.

CHECK FIGURE

Difference in favour of continuing to make switches = $5 per unit.

Exercise 12-3 Per Unit MAKE OR BUY Differential Costs 12,000 units Make Buy Make Buy Cost of purchasing $32 $384,000 Direct materials. Direct labour..... Variable manufacturing overhead ... Fixed manufacturing overhead, traceable Fixed manufacturing overhead, common Total costs Make Cost of purchasing (part 1). Cost of making (part 1) Opportunity cost-segment margin forgone on a potential new product line Total cost..... 2. Buy

Answer 1

1.)	Make Or Buy	Per unit	Differential
			Costs	12,000	Units
		Make	Buy	Make	Buy
	Cost of purchasing		32		384,000
	Direct Materials	12		144,000
	Direct labor	10		120,000
	Variable manufacturing overhead	3		36,000
	Fixed manufacturing overhead ( 8 x 25% )	2		24,000
	traceable
	Fixed manufacturing overhead	-		-
	Common
	Total Costs $	27	32	324,000	384,000

The outsider supplier offer's Should not be accepted because the cost of making is less than buy by $ 5 per unit. ( 32 - 27 )

2.)		Make	Buy
	Cost of purchasing (part-1)		384,000
	Cost of Making ( part-1 )	324,000
	Opportunity Cost- Segment margin
	forgone on a potential new product line	78,000
	Total Costs $	402,000	384,000

The outsider supplier offer's Should be accepted because the cost of making is more than buy option.