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.

correct, but each time you dont pay the price of the penalty can increase.