Question

Hart Company produces a part that is used in the manufacture of one of its products. The costs associated with the production of 5,000 units of this part are as follows:

   Direct materials   $120,000
   Direct labor    170,000
   Variable factory overhead   75,000
   Fixed factory overhead   160,000
   Total costs   $525,000

Of the fixed factory overhead costs, $70,000 are avoidable. Hart Company has offered to sell 5,000 units of the same part to Hart for $86.50 per unit. Assuming there is no other use for the facilities, should Hart Company make or buy the part?

Answer 1

A decision to buy or make depends upon lots of cost aspects relating to the production of a product or part. The avoidable cost if the product is not making is to be ascertained. When the avoidable cost is more than the cost of buying the product, it is advisable to buy the product as this would save their per unit cost.

Avoidable cost per unit = $435,000/ 5,000 = $87

Cost to buy one unit = $86.50

Savings = Avoidable cost per unit - Cost to buy one unit = $87 - $86.50 = $0.50

Hart Company should buy the product. This would save $0.50 per unit for them.