Question

Futura Company purchases the 70,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $12.60 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $12.90 as shown below:

	Per Unit			Total
Direct materials	$	6.00
Direct labor		3.00
Supervision		1.90		$	133,000
Depreciation		1.10		$	77,000
Variable manufacturing overhead		0.60
Rent		0.30		$	21,000
Total product cost	$	12.90

If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $133,000) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $88,000 per period. Depreciation is due to obsolescence rather than wear and tear.

Required:

What is the financial advantage (disadvantage) of making the 70,000 starters instead of buying them from an outside supplier?

Answer 1

Net financial advantage/ disadvantage
			BUY	MAKE	Net effect on income
Cost of Buying (70000*12.60)			882000		882000
Cost of manufacture:
Material (70000*6)				420000	-420000
labour (70000*3)				210000	-210000
variable manufacturing OH				42000	-42000
	(70000*0.60)
Supervision salaries				133000	-133000
Net Increase in income			882000	805000	77000
Net Financial advantage of manufacturing 70000 units is $ 77000