For many years Futura Company has purchased the starters tha

For many years Futura Company has purchased the starters that it installs in its standard line of farm tractors. Due to a reduction in output, the company has idle capacity that could be used to produce the starters. The chief engineer has recommended against this move, however, pointing out that the per unit cost to produce the 65,000 starters needed would be greater than the current $9.30 per unit purchase price: Per Unit $ 4.00 Direct materials Direct labor Supervision Depreciation Variable manufacturing overhead Rent 2.80 1.50 $ 97,500 1.30 $ 84,500 0.40 0.30 19,500 Total product cost $10.30 A supervisor would have to be hired to oversee production of the starters. However, the company has sufficient idle tools and machinery so 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 $84,000 per period Depreciation is due to obsolescence rather than wear and tear Required: 1. Determine the total relevant cost per unit if starters are made inside the company. (Round your answer to 2 decimal places.) cost per unit 2. Determine the total relevant cost per unit if starters are purchased from an outside supplier. (Round your answer to 2 decimal places.) cost per unit 3. What is the increase or decrease in profits as a result of purchasing the starters from an outside supplier rather than making them inside the company? (Do not round intermediate calculations. ound your answer to the nearest dollar amount.)

Solution

Part 1

Statement of Relevant cost

Direct Material

$            4.00

Direct labor

$            2.80

Supervision

$            1.50

Variable manufacturing Cost

$            0.40

$            8.70

Total Relevant cost Per Unit

$            8.70

Part 2

Total Relevant cost if starters are purchased is

$            9.30

Part 3

Only relevant cost is considered for calculation increase and decrease in profits.

Relevant cost in Purchase

$            9.30

Relevant manufacturing cost in house

$            8.70

Excess of Purchase cost Over Manufacturing

$            0.60

Number of Units

65000

Total Decrease in profits by Purchase

$ 39,000.00

Profit would decrease by $ 39000 per Period

Notes

1. Depreciation will not be considered for calculating relevant cost.

2. Supervisor salary is relevant cost even though it’s a fixed cost. Because this cost is avoidable.

3. The Amount of rent would remain the same whichever option is selected so its also a Irrelevant cost.

Part 1	Statement of Relevant cost
	Direct Material	$            4.00
	Direct labor	$            2.80
	Supervision	$            1.50
	Variable manufacturing Cost	$            0.40
		$            8.70