Question

You are given the following cost information for producing 10,000 units in LL company: direct material - $70,000, direct labour= 10,000; variable manufacturing overhead 50,000. Fixed manufacturing overhead for the year - $300,000

LL company received an offer from a supplier to manufacture the 10,000 units for $39, for the same quality. LL company can $4,000 extra net income from it. 60% of the fixed manufacturing overhead cost is avoidable if LL buys from a supplier. In case LL company decides to buy from a supplier, and use the capacity in making another product, then it will make ________________ cost savings (i.e the difference between total relevant cost of making and that of buying)

Answer 1

Total fixed manufacturing overhead = $300,000

Avoidable fixed manufacturing overhead = 300,000 x 60%

= $180,000

Unavoidable fixed manufacturing overhead =  Total fixed manufacturing overhead- Avoidable fixed manufacturing overhead

= 300,000-180,000

= $120,000

Calculation of Total Relevant Costs
	Cost of Making	Cost of Buying
Direct materials	70,000	0
Direct labor	10,000	0
Variable manufacturing overhead	50,000	0
Fixed manufacturing overhead	300,000	120,000
Opportunity cost	4,000	0
Outside supplier price	0	390,000
Total cost	$434,000	$510,000

Cost saving in making= Total cost of buying-Total cost of making

= 510,000-434,000

= $76,000