Question

Liu Inc. is considering whether to continue to make a component or to buy it from an outside supplier. The company uses 14,000 of the components each year. The unit product cost of the component according to the company's cost accounting system is given as follows:
Assume that direct labor is a variable cost. Of the fixed manufacturing overhead, 40% is avoidable if the components were bought from the outside supplier. In addition, making one component uses 1 minute on the machine that is the company's current constraint. If the components were bought, this machine time would be freed up for use on another product that requires 2 minutes on the constraining machine and that has a contribution margin of $5.00 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?
a. $24.05.
b. $21.25.
c. $18.53.
d. $21.33.

Answer 1

Answer:

Liu Inc.

In deciding whether to make or buy the component, the cost of making the component that should be compared to the price of buying it is:

= $21.71.

Explanation:

a) Data and Calculations:

                                                       Make       Buy

Units of components required    14,000    14,000

Direct materials                         $9.60  

Direct labor                                   6.70  

Variable manufacturing overhead  1.55  

Fixed manufacturing overhead      3.40  

Unit product cost                        $21.25

Unavoidable fixed overhead        (2.04) ($3.40 * 1 - 0.4)

Opportunity cost per unit              2.50 ($5.00/2)

Total avoidable cost per unit      $21.71

Direct materials                                          $9.60  

Direct labor                                                    6.70  

Variable manufacturing overhead                   1.55  

Avoidable Fixed manufacturing overhead      1.36  

Unit product cost                                          $19.21

Opportunity cost per unit                               2.50 ($5.00/2)

Total avoidable cost per unit                       $21.71