Exercise 1211 Make or Buy Decision LO123 Han Products manufa

Exercise 12-11 Make or Buy Decision [LO12-3] Han Products manufactures 29,000 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 Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total cost per part 3.70 12.00 2.30 9.00 27.00 An outside supplier has offered to sell 29,000 units of part S-6 each year to Han Products for $23 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 $79,000. 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?

Solution

Statement of Cost if Offer is Accepted

Particulars

Amount

Amount

Cost Price of Material

(29000*23)

$ 667,000.00

            Cost to be Incurred

$ 667,000.00

Less: Benefit to be Achived

$    79,000.00

             Net Cost incurred

$ 588,000.00

Statement of Cost if Offer is not Accepted

Particulars

Amount

Amount

Cost to be Incurred

Direct Material

(29000*3.7)

$ 107,300.00

Direct Labor

(29000*12)

$ 348,000.00

Variable Manufacturing Overheads

(29000*2.3)

$    66,700.00

Avoidable Fixed Cost

(261000/3*1)*

$    87,000.00

Total Cost

$ 609,000.00

*Total fixed cost (9*29000)

Statement of Comparative cost

Cost If offer is Not Accepted

$     609,000.00

Cost if Offer is Accepted

$     588,000.00

Net benefit by accepting offer

$       21,000.00

There is a financial advantage in accepting outside supplier\'s offer. The value of benefit is $ 21000.00

Notes

1) In Decision making Fixed cost is not considered exept fixed cost is avoidable.

2) Avoidable fixed cost is considered as a cost if offer is not accepted. Alternatively it could be taken as benefit to be lost if offer is not accepted.

3) The extra cost in Purchasing S-6 is compensated by extra income which will be earned only of offer is accepted so it is deducted from purchase cost of S-6.

Statement of Cost if Offer is Accepted
Particulars	Amount	Amount
Cost Price of Material	(29000*23)	$ 667,000.00
Cost to be Incurred		$ 667,000.00
Less: Benefit to be Achived		$    79,000.00
Net Cost incurred		$ 588,000.00