Question

The following production costs are provided for AudioPro Co., a manufacturer of high quality headphones.

Manufacturing Costs:

Direct Materials	$	60
Direct Labor		38
Variable Overhead		22
Fixed Overhead		50
Total	$	170

It has been determined that the headphones could be purchased from Integrated Labs at a cost of $135 plus $8 shipping costs. Considering the offer from Integrated Labs, show whether AudioPro should make or buy the product.

(a.) Assume 40% of fixed overhead allocated to making headphones relates to a production manager who would not be retained if the headphones were not produced by AudioPro.
(b.) How would your analysis change if AudioPro could use capacity resources for alternative activities that would produce a contribution of $35 per unit?
(c.) What is your understanding of the term outsourcing? Briefly explain.

Answer 1

Relevant cost of making is equal to the avoidable cost
Direct Materials	60
Direct Labor	38
Variable Overhead	22
Fixed Overhead	20
Total	140
Relevant cost of buying = 135+8 = $143
Since th cost of amking is lower, it should continue making the product
b. If the facilities can be used for another product, cost of making - relevant cost + opportunity cost
i.e. $140+35 = $175
hence, it is better to buy
c.Outsourcing is procuring a part of the product from outside manufacturer rather than producing it in house.