Han Products manufactures 30,000 units of part S-6 each year for use on its production line. At this level of activity, the cost per unit for part S-6 is as follows:
Direct materials
$ 3.60
Direct labor
10.00
Variable manufacturing overhead
2.40
Fixed manufacturing overhead
9.00
Total cost per part
$25.00
An outside supplier has offered to sell 30,000 units of part S-6 each year to Han Products for $21 per part. If Han Products accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental of $80,000. However, Han Products has determined that two-thirds of the fixed manufacturing overhead being applied to part S-6 would continue even if part S-6 were purchased from the outside supplier. Prepare computations showing how much profits will increase or decrease if the outside supplier’s offer is accepted.
If Han Products accepts the offer from the outside supplier, the profits will increase by $90,000. This is calculated as follows:
Current cost of producing 30,000 units of part S-6:
Direct materials: $108,000
Direct labor: $300,000
Variable manufacturing overhead: $72,000
Fixed manufacturing overhead: $270,000
Total cost: $750,000
Cost of purchasing 30,000 units of part S-6 from outside supplier:
Cost of purchasing: $630,000
Savings from purchasing from outside supplier:
Savings: $120,000
Fixed manufacturing overhead that will continue even if part S-6 is purchased from outside supplier:
Fixed manufacturing overhead: $180,000
Net savings from purchasing from outside supplier:
Net savings: $90,000
Increase in profits from purchasing from outside supplier:
Increase in profits: $90,000
To determine how much profits will increase or decrease if Han Products accepts the outside supplier's offer, we need to calculate the relevant costs and compare them to the outside supplier's offer.
1. Calculate the total cost of manufacturing part S-6 in-house:
- Direct materials cost per part: $3.60
- Direct labor cost per part: $10.00
- Variable manufacturing overhead cost per part: $2.40
- Fixed manufacturing overhead cost per part (2/3 of $9.00): $6.00
Total cost per part: $3.60 + $10.00 + $2.40 + $6.00 = $22.00
Total cost for 30,000 units: $22.00 * 30,000 = $660,000
2. Calculate the savings from renting out the facilities:
Annual rental income: $80,000
3. Calculate the total cost if Han Products purchases part S-6 from the outside supplier:
Total cost per part from the outside supplier: $21.00
Total cost for 30,000 units: $21.00 * 30,000 = $630,000
4. Calculate the change in fixed manufacturing overhead:
Fixed manufacturing overhead that would continue: 2/3 * $9.00 = $6.00 per part
Change in fixed manufacturing overhead: $9.00 - $6.00 = $3.00 per part
Change in fixed manufacturing overhead for 30,000 units: $3.00 * 30,000 = $90,000
5. Calculate the net effect on profits:
Net cost difference: $660,000 - $630,000 = $30,000 (Han Products spends $30,000 less)
Net rental income: $80,000
Net change in fixed manufacturing overhead: $90,000
Net effect on profits: Net cost difference + Net rental income - Net change in fixed manufacturing overhead
= $30,000 + $80,000 - $90,000 = $20,000
Based on these calculations, accepting the outside supplier's offer will result in a $20,000 increase in profits for Han Products.
To determine how much profits will increase or decrease if Han Products accepts the outside supplier's offer, we need to compare the total cost per part for manufacturing in-house versus purchasing from the outside supplier.
1. Calculate the total cost per part for manufacturing in-house:
Total cost per part = Direct materials + Direct labor + Variable manufacturing overhead + Fixed manufacturing overhead
Total cost per part = $3.60 + $10.00 + $2.40 + $9.00
Total cost per part = $25.00
2. Calculate the total cost for manufacturing in-house:
Total cost for manufacturing in-house = Total cost per part x Number of units
Total cost for manufacturing in-house = $25.00 x 30,000
Total cost for manufacturing in-house = $750,000
3. Calculate the cost if purchasing from the outside supplier:
Cost per part if purchasing = Price per part from the supplier
Cost per part if purchasing = $21.00
4. Calculate the total cost for purchasing from the outside supplier:
Total cost if purchasing = Cost per part if purchasing x Number of units
Total cost if purchasing = $21.00 x 30,000
Total cost if purchasing = $630,000
5. Determine the fixed manufacturing overhead that would continue even if part S-6 is purchased from the outside supplier:
Fixed manufacturing overhead continuing = Two-thirds of fixed manufacturing overhead
Fixed manufacturing overhead continuing = (2/3) x $9.00 x 30,000
Fixed manufacturing overhead continuing = $540,000
6. Calculate the profit increase or decrease:
Profit increase or decrease = Savings from renting facilities + Savings from fixed manufacturing overhead
Profit increase or decrease = $80,000 + ($750,000 - $630,000) + ($540,000)
Profit increase or decrease = $80,000 + $120,000 + $540,000
Profit increase or decrease = $740,000
Based on the above calculations, if Han Products accepts the outside supplier's offer, their profits will increase by $740,000.