Question

Fantasmic Productions manufactures an optical switch that is used in its final product. Fantasmic Productions incurred the following manufacturing costs last year when it produced 70,000 units

                                                                      Per unit                        

Direct materials                                                9.00                                      

Direct Labor                                                      1.50                                      

Variable factory overhead                                2.00                             

Fixed factory overhead                                     6.50                             

                                                                      $19.00                             

Fantasmic Productions has been approached by an outside supplier that has offered to supply the switches at a price of $13.50 per switch. Capacity now used to make the switches will become idle if the company purchases the switches.

Required:

ALL CALCULATIONS MUST BE SHOWN

1. Prepare a relevant cost schedule that indicates whether Fantasmic Productions should buy the switches or continue to make them.
2. Would you accept the outside supplier’s offer? Tell why or why not.
3. Assume that Fantasmic can use the released production facilities in another manufacturing activity that will make a contribution to profits of $85,0000, would that change your decision?

Answer 1

	Make Decision	Buy Decision	Net effect
Direct material	$630,000	$0	$630,000
Direct labor	105,000	0	105,000
Variable factory overhead	140,000	0	140,000
Purchase price		945,000	(945,000)
Total	$875,000	$945,000	$(70,000)

B.

As per the above analysis Offer should not be accepted as net income will decrease by $70,000 as the total relevant cost will increase by $70,000.

C.

Yes the decision may change as additional profit would result in an increase in net income by $780,000 [($875,000 - (945,000-850,000)]