Question

Questions 3 and 4 refer to the following information: X Company is considering buying a part in 2020 that it has been making for the past several years. A company has offered to supply this part for $15.21 per unit. Budgeted production in 2020 is 54,000 units, and budgeted per-unit production costs are: Materials Direct labor (all variable] Total overhead Total $5.60 4.30 5.30 $15.20 $97,200 of X Company's total overhead costs are fixed; $66,096 of the $97,200 are unavoidable even if it buys the part. Also, if X Company buys the part, it can rent the equipment that was used to make the part to another company for $80,000. 3. If X Company buys the part instead of making it, it will save Submit Answer Tries 0/3 4. At what production level would X company be indifferent between making and buying the part? Submit Answer Tries 0/3

Answer 1

Answer 3)

Make	Amount	Buy	Amount
Material (54,000 units X $ 5.60 per unit)	$ 302,400	Purchase Cost to be incurred	$ 821,340
Direct Labour (54,000 units X $ 4.30 per unit)	$ 232,200	(54,000 units X $ 15.21 per unit)
Variable overheads (54,000 units X $ 3.50 per unit)	$ 189,000	Less: Benefit from Released Capacity	$ 80,000
Avoidable Fixed Cost ($ 97,200 - $ 66,096)	$ 31,104
Relevant cost of manufacturing the component in house	$ 754,704	Relevant cost buying the component	$ 741,340

Note: Unavoidable fixed cost (i.e. $ 66,096) has not been considered for above decision making as it is a sunk cost.

Since the relevant cost of buying the component from outside supplier is less than the relevant to manufacture in house, X Company should buy the component. If it decides to buy the component its total savings will be $ 13,364 (I.e. $ 757,704 - $ 741,340)

Working Notes:

Calculation of Total variable overheads and variable overheads per unit

Budgeted Production level = 54,000 units

Total overheads = Budgeted Production in units X overhead rate per units

                               = 54,000 units X $ 5.30 per unit

                               = $ 286,200      

Therefore total overheads of the company are $ 286,200

Total fixed overhead (given in the question) = $ 97,200

Variable overheads = Total overheads – Fixed overheads

                                    = $ 286,200 - $ 97,200

                                    = $ 189,000

Therefore total variable overheads of the company are $ 189,000

Variable overhead per unit = Total variable overheads/ Budgeted production in units

                                                = $ 189,000/ 54,000 units

                                               = $ 3.50 per unit        

Therefore total variable overheads cost per unit for the company is $ 3.50

Answer 4)

Calculation of Indifferent level of Production

At indifferent level of production, total relevant cost of manufacture will be equal to relevant cost of buying the component.

Let the indifferent level of production be “y” unist.

Relevant cost of manufacture would be:

Relevant Manufacturing cost = [(Material cost per unit + Labour cost per unit + variable overheads per unit) X level of Production] + Avoidable Fixed overheads

                                                         = [($ 5.60 per units + $ 4.30 per unit + $ 3.50per unit) X y] + $ 31,104

                                                         = [$ 13.40 per unit X y] + $ 31,104

                                                         = $ 13.40y + $ 31,104

Therefore Relevant Manufacturing cost is $ 13.40y + $ 31,104

Relevant cost of buying the component would be:

Relevant Buying cost = Buying cost – Benefit from released capacity

                                      = (buying cost per units X number of units) – Benefit from released capacity

                                       = ($ 15.21 X y) - $ 80,000

                                       = $ 15.21y - $ 80,000

Therefore Relevant buying cost is $ 15.21y - $ 80,000

Equating the relevant buying cost with relevant manufacturing cost we get:

$ 15.21y - $ 80,000 = $ 13.40y + $ 31,104

$ 1.81y = $ 111,104

Y = 61,383.42 units or 61,384 units (approximately)

Thus the company would be indifferent between manufacturing the component and buying it from outside market of the level of production is 61,384 units (approximately).

Comparison of Cost at the indifferent level of production (61,384 units)

Make	Amount	Buy	Amount
Material (61,384 units X $ 5.60 per unit)	343750.4	Purchase Cost to be incurred	933650.6
Direct Labour (61,384 units X $ 4.30 per unit)	263951.2	(61,384 units X $ 15.21 per unit)
Variable overheads (61,384 units X $ 3.50 per unit)	214844	Less: Benefit from Released Capacity	80000
Avoidable Fixed Cost ($ 97,200 - $ 66,096)	31104
Relevant cost of manufacturing the component in house	853649.6	Relevant cost buying the component	853650.6

Note: from the perusal of above table, it is clear that at 61,384 units the relevant cost to buy and relevant cost to manufacture would be approximately equal.