Innova uses 1,097 units of the component IMC2 every month to manufacture one of

ID: 2504578 • Letter: I

Question

Innova uses 1,097 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 $60.00 Direct labor 36.00 Overhead 126.50 Total $222.50
Overhead costs include variable material handling costs of $6.50, 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 $292.00 per unit.

Prepare the incremental analysis for the decision to make or buy IMC2

Make IMC2 (per unit) Buy IMC2 (per unit) Net Income
Increase (Decrease) Direct material $ $ $ Direct labor Material handling Variable overhead Purchase price Total unit cost $ $ $
Should Innova purchase the component from the outside vendor if Innova

Explanation / Answer

Make (i)

Buy (ii)

Net Income Effect (i-ii)

Direct Material

Direct Labor

Material Handling

6.5

Variable Overhead

Purchase Price

292

-292

Total Unit Cost

174.5

292

-117.5

NOTE 1:
The fixed overhead costs that are still incurred per unit is (126.5 6.5)*40% = $48 per unit.
Total Fixed Costs = 48*1097 = $52,656

NOTE 2:
The variable costs that are incurred per unit is (126.5 6.5)*60% = $72 per unit.

NOTE 3:
The increase in costs or losses due to purchase is = 117.5*1097 = $128,897.5

NOTE 4:
We will purchase the part from outside only if the resources which will not be used can generate atleast $128,897.5 of profits. In our case, the assets will remain idle.
HENCE, WE MAKE THE PRODUCT.