Question

Devon Firm is considering whether to outsource the manufacture of subcomponent XYZ. The accounting department provides the following cost information for manufacturing 10,000 units of the subcomponent XYZ per month.

Direct Material Costs	$42,000
Direct Labour Costs	$32,500
Variable Overhead	$14,000
Fixed Overhead*	$12,500

*Fixed overhead includes $5,000 Supervisor’s salary.

Stadia Firm agrees to supply Devon with 10,100 units per month for a total cost of $122,500. If the subcomponent XYZ is outsourced, Devon will be able to increase the production and sales of its final product by 1,000 units per month, which is sold for $105 per unit and its average variable costs per unit are $73. The supervisor’s salary will be eliminated if subcomponent XYZ is outsourced.

Required:

a. Prepare an incremental analysis for the subcomponent XYZ. Your analysis should have columns for (1) Make the subcomponent XYZ, (2) Buy the subcomponent XYZ, and (3) Incremental Costs (Savings)

b. Based on your analysis, what decision should management make?

c. Would the decision be different if Devon has the opportunity to produce 2,000 units with the facilities currently being used to manufacture the subcomponent XYZ? Show calculations.

Answer 1

A)

Increase in final earnings if outsourced =

= 1000 units * (105-73)

= $32000

Incremental analysis

Particulars	Make	Buy	incremental cost if make
Direct material	$42000		$42000
Direct labor	$32500		$32500
Variable overhead	$14000		$14000
Fixed overhead	$12500	$7500	$5000
Cost if outsourced		$122500	($122500)
Incremental revenue (opportunity cost)	$32000	-	$32000
Total	$133000	$130000	$3000

B) since there is an incremental cost of $3000 if XYZ is manufactured, hence managment should outsource it

C)

in this case opportunity cost will change.

New opportunity cost = 2000 * ( 105-73)

= $64000

In this case there will be incremental cost of $35000 . Hence decision will not be changed.