Question

Innova uses 1,100 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 $63.96 Direct labor 41.72 Overhead 126.50 Total $232.18 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 $250 per unit.
Prepare the incremental analysis for the decision to make or buy IMC2. Should Innova purchase the component from the outside vendor if Innova's capacity remains idle?

Answer 1

Answer:

a.                       Make IMC2       Buy IMC2           N.I. Increase/(Decrease)

Direct Materials        $63.96                                                   $63.96

Direct Labor              $41.72                                                    $41.72

Material handling    $7.50                                                     $7.50

Variable Overhead   $71.40                                                    $71.40

Purchase Price                                $250.00                         -$250.00

Total Unit Cost          $184.58       $250.00                         -$65.42  

Workings: Variable Overhead  = ($126.5 - $7.5) x 60% = $71.40

b. No, Innova should not purchase the component from the outside vendor if Innova's capacity remains idle.