CaseStudy

Relevant Cost/Make or Buy Decision Part U67 is used in one of Broce Corporation’s products. The company’s Accounting Department reports the following costs of producing the 7,000 units of the part that are needed every year.

Per Unit Direct materials…………………………………… $8.70

Direct labor ………………………………………… $2.70

Variable overhead ……………………………….. $3.30

Supervisor’s salary………………………………. $1.90

Depreciation of special equipment ………… $1.80

Allocated general overhead…………………… $5.50

An outside supplier has offered to make the part and sell it to the company for $21.40 each. If this offer is accepted, the supervisor’s salary and all of the variable costs, including direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company. If the outside supplier’s offer were accepted, only $6,000 of these allocated general overhead costs would be avoided.

Required:

a. Prepare a report that shows the effect on the company’s total net operating income of buying part U67 from the supplier rather than continuing to make it inside the company.

b. Which alternative should the company choose?