Zion Manufacturing had always made its components in-house. However, Bryce Component Works had recently offered to supply one component, K2, at a price of $25 each. Zion uses 10,000 units of Component K2 each year. The cost per unit of this component is as follows:

Direct materials $12.00
Direct labor 8.25
Variable overhead 4.50
Fixed overhead 2.00
Total $26.75

The fixed overhead is an allocated expense; none of it would be eliminated if the production of Component K2 stopped.
Required:
List the relevant costs for each alternative. If required, round your answers to the nearest cent.

Total Relevant Cost
Make $ per unit
Buy $ per unit
Differential Cost to Make $ per unit

If Zion decides to purchase the component from Bryce, by how much will operating income increase or decrease?

The Alternative to Make the product is better.

Explanation:

Requirement 1:

Calculate relevant costs for each alternative as shown below:

Detai                     Make                            Buy

Relevant Costs:

Purchase Cost                                         $25.00

Direct Material          $12.00

Direct Labour            $8.25

Variable overhead         $4.50

Total                    $24.75                        $25.00

Differential cost to make per unit

($2435-$25 .00)

($0.25)

If production of Component 1(2 stopped, none of fixed costs would be eliminated. None  of the fixed cost is relevant.

If Z purchase the component from outside supplier, then Z’s operating income will be decreased by $2,500 (10,000 units x $0.2sper unit). As the differential cost to make perunit is $0.25 less than to buy alternative. Hence, operating income will be decreased.

Calculate total relevant cost if 75% of fixed cost is eliminated

Avoidable fixed cost = ($2.00 X 75%) = $1.50

Details                Make                    Buy

Relevant Costs:

Purchase Cost                                $25.00

Direct Material      $12.00

Direct Labour        $8.25

Variable overhead      $4.50

Fixed overhead (Avoidable 75%j $2 x 75%)

$1.50

Total Relevant cost   $26.25                    $25.00

Differential cost to make per unit

($26.25-$25.00)

$1 25

.

In this situation, relevant cost $1.25 more to make the component rather than to buy.

If Z buy the component from outside supplier, Z’s operating income will be increased by

$12,500 ($1.25 X 10,000).

Requirement 2:

Relevant fixed cost per unit must decrease by $1.25 from $1.50 to $0.25 to make Z

indifferent.

Details              Make                Buy

Relevant Costs:

Purchase Cost                         $25.00

Direct Material     $12.00

Direct Labour       $815

Variable overhead   $4.50

Fixed overhead (Avoidable) $0.25

Total Relevant cost  $25.00              $25.00

Differential cost to make per unit

(S25.00-$25.00)

Hence, at this point, total cost to make the component and to buy the component would  be the same.

answer; test-retest;

c.

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