Wednesday, 1 April 2015

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.

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 $21 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   15,800 Units
Per Year
  Direct materials $ 5    $ 79,000  
  Direct labor   7      110,600  
  Variable manufacturing overhead   4      63,200  
  Fixed manufacturing overhead, traceable   6*     94,800  
  Fixed manufacturing overhead, allocated   9      142,200  
 



  Total cost $ 31    $ 489,800  
 








*40% supervisory salaries; 60% depreciation of special equipment (no resale value).
  
Required:
1a.
Assuming that the company has no alternative use for the facilities that are now being used to produce the carburetors, compute the total cost of making and buying the parts.

1b. Should the outside supplier’s offer be accepted?
     
  Reject
   
2a.
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 $46,080 per year. Compute the total cost of making and buying the parts.


Exercise 12-3 Make or Buy a Component [LO12-3]
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 $21 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   15,800 Units
Per Year
  Direct materials $ 5    $ 79,000  
  Direct labor   7      110,600  
  Variable manufacturing overhead   4      63,200  
  Fixed manufacturing overhead, traceable   6*     94,800  
  Fixed manufacturing overhead, allocated   9      142,200  
 



  Total cost $ 31    $ 489,800  
 








*40% supervisory salaries; 60% depreciation of special equipment (no resale value).
  
Required:
1a.
Assuming that the company has no alternative use for the facilities that are now being used to produce the carburetors, compute the total cost of making and buying the parts. (Round your Fixed manufacturing overhead per unit rate to 2 decimals.)
    save image
      
1b. Should the outside supplier’s offer be accepted?
     
  Reject
   
2a.
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 $46,080 per year. Compute the total cost of making and buying the parts. (Round your Fixed manufacturing overhead per unit rate to 2 decimals.)
  
        save image

2b.
Should Troy Engines, Ltd., accept the offer to buy the carburetors for $21 per unit?
     
  Accept




Explanation:1.
   
Per Unit
Differential
Costs
 
15,800 Units
    Make   Buy   Make   Buy
  Cost of purchasing     $ 21        $ 331,800  
  Direct materials $ 5         $ 79,000      
  Direct labor   7           110,600      
  Variable manufacturing overhead   4           63,200      
  Fixed manufacturing overhead, traceable1   2.40           37,920      
  Fixed manufacturing overhead, common   -           -     -  
 







  Total costs $ 18.40     $ 21    $ 290,720   $ 331,800  
 















  Difference in favor of continuing to make the carburetors $2.60 $41,080

   
1Only the supervisory salaries can be avoided if the carburetors are purchased. The remaining book value of the special equipment is a sunk cost hence, the $4 per unit depreciation expense is not relevant to this decision.
 
Based on these data, the company should reject the offer and should continue to produce the carburetors internally.
   
2a.

    Make   Buy
  Cost of purchasing (part 1)     $ 331,800  
  Cost of making (part 1) $ 290,720      
  Opportunity cost—segment margin forgone on a potential new product line   46,080      
 



  Total cost $ 336,800   $ 331,800  
 







  Difference in favor of purchasing from the outside supplier   $5,000  

   
2b.
Thus, the company should accept the offer and purchase the carburetors from the outside supplier.