Question

Han Products manufactures 22,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is:

Direct materials	$	3.60
Direct labor		10.00
Variable manufacturing overhead		2.40
Fixed manufacturing overhead		6.00
Total cost per part	$	22.00

An outside supplier has offered to sell 22,000 units of part S-6 each year to Han Products for $20 per part. If Han Products accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental of $72,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier.

Required:

What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?

Answer 1

Particulars	Making cost	Purchase cost
Direct materials ($3.60 * 22,000)	$79,200	-
Direct labor ($10.00 * 22,000)	$220,000	-
Variable manufacturing cost ($2.40 * 22,000)	$52,800	-
Fixed manufacturing overhead	($6*22,000) $132,000	($132,000 * 2/3) $88,000
Cost of purchase ($20 * 22,000)	-	$440,000
	$484,000	$528,000
(-) Rent	-	$72,000
Total cost	$484,000	$456,000

financial advantage of accepting the outside supplier’s offer is ($484,000 - $456,000) $28,000.