Question

A company manufactures components for use in producing one of its finished products. when 12,000 units are produced, the full cost per unit is $35, separated as follows: direct materials $ 5 direct labor 15 variable overhead 10 fixed overhead 5 a supplier has offered to sell 12,000 components to the company for $37 each. if the company accepts the offer, some of the facilities currently being used to manufacture the components can be rented as warehouse space for $40,000. however, $3 of the fixed overhead currently applied to each component would have to be covered by the company's other products. what is the differential cost to the company of purchasing the components from the supplier?

Answer 1

Cost of Making the product is as below, We shall exclude the amount of $3 per unit of fixed cost as it is not a relevant cost

Cost of Manufacturing Cost of Buying Difference

Direct Materials $5

Direct Labour $15

Variable Overheads $10

Fixed Overheads $2

Total Manufacturing Cost $32

Total Purchase Cost $37

Total Cost (12000 Units) 384000 444000 60000

Rent Income (40000) (40000)

Total Difference 20000

Thus as can be observed above the company incurs an extra cost of $20000 if it purchases the component from a third party. Thus its advisable if the company produces the component in its own premises.