Question

Futura Company purchases the 79,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $13.30 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 $13.70 as shown below:

	Per Unit			Total
Direct materials	$	7.00
Direct labor		2.80
Supervision		1.70		$	134,300
Depreciation		1.30		$	102,700
Variable manufacturing overhead		0.50
Rent		0.40		$	31,600
Total product cost	$	13.70

If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $134,300) 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 79,000 starters instead of buying them from an outside supplier?

Answer 1

Note : The depreciation cost & rent cost are unavoidable costs in nature thus both costs won't be consider for evaluating  financial advantage (disadvantage) of making the starters.

Total cost of making 79,000 starters =  [Total product cost per unit (given) - Depreciation - Rent ] * 79,000

= ($13.70 - $1.30 - $0.40) * 79,000 starters = $948,000

Total cost of buying 79,000 starters = Purchase price per unit * 79,000

= $13.30 * 79,000 starters = $1,050,700

Financial advantage (disadvantage) of making the 79,000 starters

= Total cost of buying - Total cost of making

= $1,050,700 - $948,000 = $102,700

Conclusion : Thus it is recommended to make the starters as it will save $102,700 in costs.