Question

Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has always produced all of the necessary parts for its engines, including all of the carburetors. An outside supplier has offered to sell one type of carburetor to Troy Engines, Ltd., for a cost of $36 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally:
Per Unit 20,000 Units per Year Direct materials $ 13 $ 260,000 Direct labor 11 220,000 Variable manufacturing overhead 4 80,000 Fixed manufacturing overhead, traceable 6 * 120,000 Fixed manufacturing overhead, allocated 9 180,000 Total cost $ 43 $ 860,000 *One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).

Required:

1. Assuming the company has no alternative use for the facilities that are now being used to produce the carburetors, what would be the financial advantage (disadvantage) of buying 20,000 carburetors from the outside supplier?

2. Should the outside supplier’s offer be accepted?

3. Suppose that if the carburetors were purchased, Troy Engines, Ltd., could use the freed capacity to launch a new product. The segment margin of the new product would be $200,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 20,000 carburetors from the outside supplier?

4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Answer 1

Answer:

1. Financial Disadvantage $140,000

2. Do not accept

3. Financial Advantage $ 60,000

4. Accept

Explanation:

Consider the costs and savings that will arise as a result of the Purchase

Purchase ($36 × 20,000)                                                      (720,000)

Direct materials ($ 13 × 20,000)                                            260,000

Direct labor ($11  × 20,000)                                                    220,000

Variable manufacturing overhead ($4  × 20,000)                 80,000

Fixed manufacturing overhead, traceable ($6  × 20,000)  120,000

Fixed manufacturing overhead, allocated ($9× 20,000)     180,000

Incremental Income / (loss)                                                   (140,000)

Do not accept as will result in the incremental loss of $140,000

Consider the costs and savings that will arise as a result of the Purchase

Purchase ($36 × 20,000)                                                      (720,000)

New Segment                                                                         200,000

Direct materials ($ 13 × 20,000)                                            260,000

Direct labor ($11  × 20,000)                                                    220,000

Variable manufacturing overhead ($4  × 20,000)                 80,000

Fixed manufacturing overhead, traceable ($6  × 20,000)  120,000

Fixed manufacturing overhead, allocated ($9× 20,000)     180,000

Incremental Income / (loss)                                                     60,000

Accept as this will result in incremental profit of $60,000