Question

Aisin Company manufactures a component (T-20Z) used in their final products. Saman Silva, the management accountant, has been assigned the task of determining whether this component should continue to be manufactured by the company or purchased from Sumimoto Limited, an outside supplier. Sumimoto Limited has submitted a bid to manufacture and supply 40,000 units of T20Z the company needs for next year at a unit price of $25.

Saman has gathered the following information regarding the cost of manufacturing 40,000 units of T20Z in the current year.

Per unit Total

Direct material $12.00 $480,000

Direct labour $6.00 $240,000

Factory space rental $4.00 $160,000

Equipment leasing costs $3.00 $120,000

Fixed manufacturing overhead $5.00 $200,000

Total manufacturing costs n $30.00 $1,200,000

Saman has also collected the following additional information related to manufacturing T20Z.

• Direct materials used in the production of T20Z are expected to increase by 20% next year.

• Direct labour costs are expected to increase by 10% next year.

• The rental agreement of the facilities to manufacture the T20Z, costing $160,000, can be withdrawn anytime without any penalty. The company has no need for this space if T20Z is not manufactured.

• The lease for special equipment used to manufacture T20Z, costing $120,000 annually, can be terminated by paying the equivalent of one month’s lease payment for each year left on the lease agreement. The company has three years left on the lease agreement from the beginning of next year.

• The fixed manufacturing overhead costs are not expected to change regardless of whether T20Z is manufactured or not.

Required: (a) Prepare an analysis of relevant costs that shows whether or not the Aisin Company should make T20Z or purchase it from Sumitomo Limited next year.

(b) Identify and briefly discuss qualitative factors that the company should consider before agreeing to purchase T20Z from Sumitomo Limited.

Answer 1