Question

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Han Products manufactures 22,000 units of part 5-6 each year for use on its production line. At this level of activity, the cost per unit for part 5-6 is: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total cost per part $ 3.60 10.00 2.40 6.00 $ 22.00 An outside supplier has offered to sell 22,000 units of part 5-6 each year to Han Products for $20 per part. If Han Products accepts this offer, the facilities now being used to manufacture part 5-6 could be rented to another company at an annual rental of $72,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part 5-6 would continue even if part 5-6 were purchased from the outside supplier. Required: What is the financial advantage (disadvantage) of accepting the outside supplier's offer?

Answer 1

per unit and total relevant cost for buying and making the product will be computed as follows:

	Per Unit Relevant Costs Make	Per Unit Relevant Costs Buys	22,000 Units Make	22,000 Units Buy
Cost of Purchasing		20		4,40,000
Cost of Making:
Direct materials	3.6		79,200
Direct labor	10		2,20,000
Variable overhead	2.4		52,800
Fixed overhead	2		44,000
Total	18	20	396,000	440,000

Note: In a make or buy decision, relevant costs are costs that can be avoided if the company purchases the product from an outside supplier. Therefore, only $2 ($6 x 1/3) per unit of fixed overhead costs are relevant because $4 ($6 x 2/3) of fixed overhead costs are unavoidable

There is financial disadvantage of accepting the outside supplier offer because,cost of buying is more than the cost of manufacturing the part s-6

Financial disadvantage would be = $396,000 - 440,000 = ($44,000)

Part (b)

Calculation of financial advantage or disadvantage on droping linens department

Particulars	Amounts $
Contribution Margin lost of linens department	(790,000)
Contribution margin lost of Hardware department(2,196,000*18%)	(395,280)
Total contribution margin lost	(1,185,280)
Add:Avoidable fixed cost (840,000 - 376,000)	464,000
Net financial disadvantage	(721,280)