Question

Wilma Company must decide whether to make or buy some of its components. The costs of producing 60,500 switches for its generators are as follows.

Direct materials		$29,600		Variable overhead		$44,400
Direct labor		$21,480		Fixed overhead		$83,600

Instead of making the switches at an average cost of $2.96 ($179,080 ÷ 60,500), the company has an opportunity to buy the switches at $2.70 per unit. If the company purchases the switches, all the variable costs and one-fourth of the fixed costs will be eliminated.

Prepare an incremental analysis showing whether the company should make or buy the switches. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Answer 1

	Cost if Manufacture (A)	Cost if Buy (B)	Increase/ -Decrease in cost due to buying (B-A)
Direct material	29600	0	-29600
Direct labour	21480	0	-21480
Variable overhead	44400	0	-44400
Fixed overhead	83600	62700	-20900
		(3/4*83600)
Purchase cost		163350	163350
		(60500*2.7)
Total	179080	226050	46970
As the cost increase in buying alternative compared to manufacture alternative, company should continue to manufacture.
Additional: Just for information : The reason here is even when we choose to buy the 3/4th of the fixed cost continue to occur thereby increasing overall cost in buying alternative.