Question

Exercise 6-11 (Algo) Make or Buy Decision [LO6-3]

Han Products manufactures 33,000 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	$	3.70
Direct labor		10.00
Variable manufacturing overhead		2.30
Fixed manufacturing overhead		12.00
Total cost per part	$	28.00

An outside supplier has offered to sell 33,000 units of part S-6 each year to Han Products for $22 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 $83,000. 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?

determine if Financial advantage or financial disadvantage and then the $amount of it

Answer 1

Solution

Financial advantage of accepting offer = $17000

Working

Differential Analysis
	Make	Buy
Direct material	$ 122,100
Direct labor	$ 330,000
Variable Overheads	$ 75,900
Fixed overhead	$ 132,000
Purchase price		$ 726,000
Additional benefit from Buying from outside		-$ 83,000
Total relevant Cost	$ 660,000	$ 643,000

Total Cost of Buying	$ 643,000
Total Cost of manufacturing	$ 660,000
Cost saving if Outside offer is accepted	$ 17,000

The cost of Buying is less than cost of manufacturing hence it is better to buy from outside.