Question

Benson Corp. manufactures a variety of parts for use in its product. The company has always produced all of the necessary parts for its product, including all of the electronic circuits. The company sells 17,000 units of its product per year. An outside supplier has offered to sell electronic circuits to the company for a cost of $35 per unit. To evaluate this offer, the company has gathered the following information relating to its own cost of producing the electronic circuits internally:

	Per Unit				17,000 Units per Year
Direct materials	$	17		$	289,000
Direct labor		8			136,000
Variable manufacturing overhead		4			68,000
Fixed manufacturing overhead, traceable		6	*		102,000
Fixed manufacturing overhead, allocated		9			153,000
Total cost	$	44		$	748,000

*One-third supervisory salary; two-thirds depreciation of special equipment (no resale value).

Suppose that if the electronic circuits were purchased, the division supervisor position could be eliminated. Fixed manufacturing overhead will be allocated to other products made by the company. Also, the company could use the freed production capacity to launch a new product. The segment margin of the new product would be $170,000 per year. Given this new assumption, how much would be the financial advantage of buying 17,000 electronic circuits from the outside supplier?

Multiple Choice

• $153,000

• $122,000

• $68,000

• $102,000

Answer 1

If company decides to buy from outside supplier,

Costs = 17000 * $35 = $595,000

Benefits = Savings by not self producing + new product margin

Savings = Direct material + direct labor + variable OH + Supervisor salary

( Special equipment depreciation wont be considered as the equipmnt as no resale value and also, allocated fixed OH would still occur)

Hence, savings = 17 + 8 + 4 + 1/3 of 6 = $31

Total savings = 17000 * $31 = $527,000

Benefits = $527,000 + $170,000 = $697,000

Financial advantage = benefits - cost = 697,000 - 595,000 = $102,000