Dentech, Inc., uses 11 units of part RM67 each month in the production of dentistry equipment. The cost of manufacturing one unit of RM67 is the following:
Direct material $ 2,000
Material handling (20% of direct-material cost) 400
Direct labor 32,000
Manufacturing overhead (150% of direct labor) 48,000
Total manufacturing cost $ 82,400
Material handling represents the direct variable costs of the Receiving Department that are applied to direct materials and purchased components on the basis of their cost. This is a separate charge in addition to manufacturing overhead. Dentech’s annual manufacturing overhead budget is one-third variable and two-thirds fixed. Scott Supply, one of Dentech’s reliable vendors, has offered to supply part number RM67 at a unit price of $53,000.
Required:
| 1. |
If Dentech purchases the RM67 units from Scott, the capacity Dentech used to manufacture these parts would be idle. Should Dentech decide to purchase the parts from Scott, the unit cost of RM67 would increase (or decrease) by what amount? |
| 2. |
Assume Dentech is able to rent out all its idle capacity for $83,000 per month. If Dentech decides to purchase the 11 units from Scott Supply, Dentech’s monthly cost for RM67 would increase (or decrease) by what amount? |
| 3. |
Assume that Dentech does not wish to commit to a rental agreement but could use its idle capacity to manufacture another product that would contribute $167,000 per month. If Dentech’s management elects to manufacture RM67 in order to maintain quality control, what is the net amount of Dentech’s cost from using the space to manufacture part RM67? |
Solution 1:
| Differential Analysis - Making RM67 (alt 1) or Buying RM67 (Alt2) | |||
| Particulars | Making RM 67 (Alt 1) | Buying RM67 (Alt 2) | Increase (Decrease) in cost (Alternative 2) |
| Costs: | |||
| Purchase Price | $0.00 | $53,000.00 | $53,000.00 |
| Direct material | $2,000.00 | $0.00 | -$2,000.00 |
| Material handling | $400.00 | $0.00 | -$400.00 |
| Direct labor | $32,000.00 | $0.00 | -$32,000.00 |
| Variable manufacturing overhead ($48,000*1/3) | $16,000.00 | $0.00 | -$16,000.00 |
| Total Cost | $50,400.00 | $53,000.00 | $2,600.00 |
As unit cost of RM67 will increase by $2,600 per unit for buying option, therefore Dentech should make this product in house.
Solution 2:
| Differential Analysis - Making RM67 (alt 1) or Buying RM67 (Alt2) | |||
| Particulars | Making RM 67 (Alt 1) | Buying RM67 (Alt 2) | Increase (Decrease) in cost (Alternative 2) |
| Costs: | |||
| Purchase Price (11*$53,000) | $0.00 | $583,000.00 | $583,000.00 |
| Direct material | $22,000.00 | $0.00 | -$22,000.00 |
| Material handling | $4,400.00 | $0.00 | -$4,400.00 |
| Direct labor | $352,000.00 | $0.00 | -$352,000.00 |
| Variable manufacturing overhead ($48,000*1/3*11) | $176,000.00 | $0.00 | -$176,000.00 |
| Opportunity cost renting of idle capacity | $83,000.00 | $0.00 | -$83,000.00 |
| Total Cost | $637,400.00 | $583,000.00 | -$54,400.00 |
If Dentech decides to purchase the 11 units from Scott Supply, dentech monthly cost for RM 67 will decrease by $54,400.
Solution 3:
Contribution loss on opportunity to manufacture another product using idle space = $167,000
Saving in cost in making RM 67 over buying the same from Scott = $2,600 * 11= $28,600
Therefore net amount of Dentech’s cost from using the space to manufacture part RM67 = $167,000 - $28,600 = $138,400
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