Question

Rundle Chemical Company makes a variety of cosmetic products, one of which is a skin cream designed to reduce the signs of aging. Rundle produces a relatively small amount (15,000 units) of the cream and is considering the purchase of the product from an outside supplier for $5.40 each. If Rundle purchases from the outside supplier, it would continue to sell and distribute the cream under its own brand name. Rundle’s accountant constructed the following profitability analysis:

Revenue (15,000 units × $13.50)	$	202,500
Unit-level materials costs (15,000 units × $1.40)		(21,000	)
Unit-level labor costs (15,000 units × $0.80)		(12,000	)
Unit-level overhead costs (15,000 × $0.20)		(3,000	)
Unit-level selling expenses (15,000 × $0.60)		(9,000	)
Contribution margin		157,500
Skin cream production supervisor’s salary		(53,000	)
Allocated portion of facility-level costs		(13,400	)
Product-level advertising cost		(48,000	)
Contribution to company-wide income	$	43,100

Required

1. Identify the cost items relevant to the make-or-outsource decision.

2. What is the avoidable cost per unit if the outsourcing decision is taken? Should Rundle continue to make the product or buy it from the supplier?

3. Suppose that Rundle is able to increase sales by 12,000 units (sales will increase to 27,000 units). Calculate the total avoidable costs. At this level of production, should Rundle make or buy the cream?

Answer 1

a.Relevant costs are the avoidable costs of making
Material	21,000
Labor costs	12,000
Overhead costs	3,000
Production supervisor's salary	53,000
Relevant costs	89,000
Selling and advertising costs will be incurred in both the cases
Allocated costs are irrelevant as they are unavoidable
b.Avoidable cost per unit = 89000/15000 = $5.9333
Should buy since purchase cost is lower
c.Total avoidable costs = 36000*27000/15000 + 53000 = $117,800
i.e. $4.36 per unit
Should make, as purchase cost is higher