Question

Innova uses 1,000 units of the component IMC2 every month to manufacture one of its products. The unit costs incurred to manufacture the component are as follows.
Direct materials $61.17
Direct labor 43.50
Overhead 126.50
Total $231.17
Overhead costs include variable material handling costs of $7.50, which are applied to products on the basis of direct material costs. The remainder of the overhead costs are applied on the basis of direct labor dollars and consist of 60% variable costs and 40% fixed costs. A vendor has offered to supply the IMC2 component at a price of $200 per unit.
Required:
(a) Prepare the incremental analysis for the decision to make or buy IMC2.
(b) Should Innova purchase the component from the outside vendor if Innova’s capacity remains idle?

Answer 1

Answer:

a) Increase in cost as result of buying = $(6,430)

b) Decision

Innova should make the components internally, doing so would save it  $6,430.

Explanation:

Variable material overhead = $7.50

Variable labor cost = 60%× (126.50  - 7.50 )= $71.4

Total variable overhead = 7.50 + 71.4 =  $78.9

Unit variable cost = 61.17 + 43.50 + 78.9 = $193.57

Note that the balance of fixed costs were not considered because they are not relevant . This implies that they would be incurred either way.

                                                                                                $

Variable cost of making ($193.57× 1,000)             =     193,570

Variable cost of external purchase  ($200× 1,000) = 200,000

Extra variable cost  of buying                                          (6,430)

Buying the product externally would increase total cost by $(6,430)

Increase in cost as result of buying = $(6,430)

Decision

Innova should make the components internally, doing so would save it  $6,430.