Q18E - Horngren'S Financial And Managerial Accounting

Question

Cool Systems manufactures an optical switch that it uses in its final product. The switch has the following manufacturing costs per unit:

Direct materials                                                       \(5.00

Direct labor                                                              3.00

Variable overhead                                                  6.00

Fixed overhead                                                       7.00

Manufacturing product cost                               \)21.00

 

Another company has offered to sell Cool Systems the switch for $15.00 per unit. If Cool Systems buys the switch from the outside supplier, the idle manufacturing facilities cannot be used for any other purpose, yet none of the fixed costs are avoidable. 

Prepare an outsourcing analysis to determine whether Cool Systems should make or buy the switch.

Step-by-Step Solution

Answer

The company should make the product in-house.

 

Step 1: Meaning of Avoidable Fixed Cost

Avoidable fixed cost refers to the expenses that are not required to be incurred by acompany if the production does not occur. In addition, avoidable fixed costs are relevant for making decisions such as outsourcing and dropping a product or service.

 

Step 2: Preparation of outsourcing analysis

 

Outsourcing Analysis
Outsourcing Analysis
Particulars	Make ($)	Buy ($)
Variable cost per unit:
Direct material	5
Direct labor	3
Variable overhead	6
Purchase price offered by outside supplier		15
Total	$14	$15

 Decision:

The making cost of the product is less than the outsourcing price. The company, therefore, should continue making the product instead of outsourcing it.