Question

# Problem 10-23A Make or Buy Decision [LO10-3] Silven Industries, which manufactures and sells a highly successful...

Problem 10-23A Make or Buy Decision [LO10-3] Silven Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin. After considerable research, a winter products line has been developed. However, Silven’s president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated. The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for \$8 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a \$90,000 charge for fixed manufacturing overhead will be absorbed by the product under the company’s absorption costing system. Using the estimated sales and production of 100,000 boxes of Chap-Off, the Accounting Department has developed the following cost per box: Direct materials \$ 3.60 Direct labor 2.00 Manufacturing overhead 1.40 Total cost \$ 7.00 The costs above include costs for producing both the lip balm and the tube that contains it. As an alternative to making the tubes, Silven has approached a supplier to discuss the possibility of purchasing the tubes for Chap-Off. The purchase price of the empty tubes from the supplier would be \$1.35 per box of 24 tubes. If Silven Industries accepts the purchase proposal, direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and direct materials costs would be reduced by 25%.

Firstly we need to seperate fixed manufacturing overhead per unit and variable manufacturing overhead per unit from the manufacturing overhead of \$1.40 per box.

Fixed manufacturing OH per unit = Fixed manufacturing overhead/Total boxed produced

= \$90,000/100,000 boxes = \$0.90 per box

Variable manufacturing OH per unit = \$1.40 - \$0.90 = \$0.50 per box

Savings in cost by purchasing empty tubes (Amounts in \$)

 Savings in Direct materials per box (\$3.60*25%) 0.9 Savings in Direct labor per box (\$2.00*10%) 0.2 Savings in Variable manufacturing overhead (\$0.50*10%) 0.05 Total savings in cost 1.15

Total cost of purchase of empty tube = \$1.35 per box

As total saving in cost per box by purchasing empty tubes of \$1.15 is less than purchase price of \$1.35 per box, the company should not accept the proposal because there is a disadvantage of \$0.20 per box in purchasing of tubes.

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