Sardi Inc. is considering whether to continue to make a component or to buy it from an outside supplier. The company uses 13,400 of the components each year. The unit product cost of the component according to the company's cost accounting system is given as follows: Direct materials $ 9.20 Direct labor 6.20 Variable manufacturing overhead 2.00 Fixed manufacturing overhead 4.00 Unit product cost $ 21.40 Assume that direct labor is a variable cost. Of the fixed manufacturing overhead, 35% is avoidable if the component were bought from the outside supplier. In addition, making the component uses 1 minutes on the machine that is the company's current constraint. If the component were bought, time would be freed up for use on another product that requires 2 minutes on this machine and that has a contribution margin of $5.60 per unit. When deciding whether to make or buy the component, what cost of making the component should be compared to the price of buying the component

Thus total manufacturing cost per unit which is variable and fixed cost which can be revoked in case of buying shall be considered, while making this decision, also the contribution to be received from another component in case of buying this component shall be considered.

Explanation:

Total cost when the company manufactures it will be as follows:

Variable = Direct material + Direct Labor + Variable Manufacturing Overhead

= $9.20 + $6.20 + $2 = $17.40 per unit = $17.40 [tex]\times[/tex] 13,400 = $233,160

Fixed = $4 [tex]\times[/tex] 13,400 = $53,600

Total = $286,760

In case of buy option,

Total cost of buying the component = Fixed cost 65% =

$53,600 [tex]\times[/tex] 65% = $34,840

Additional savings in the form of component = $5.60 contribution per unit of alternative product = 13,400/2 [tex]\times[/tex] $5.60 = $37,520

Also there will be additional cost of buying component per unit

Still this will be beneficial in any manner where the cost is less than $17.40 per unit as there is benefit of contribution from alternative component manufactured.

Thus total manufacturing cost per unit which is variable and fixed cost which can be revoked in case of buying shall be considered, while making this decision, also the contribution to be received from another component in case of buying this component shall be considered.