Golden,Inc.has been manufacturing 5,000 units of Part 10541 which is used in one of its products.At this level of production,the unit product cost of Part 10541 is as follows: Brown Company has offered to sell Golden 5,000 units of Part 10541 for $19 a unit.Golden has determined that two thirds of the fixed manufacturing overhead will continue even if Part 10541 is purchased from Brown.Assume that direct labour is an avoidable cost in this decision.To determine whether to accept Brown's offer,the relevant costs to Golden of manufacturing the parts internally are:

Question

Golden,Inc.has been manufacturing 5,000 units of Part 10541 which is used in one of its products.At this level of production,the unit product cost of Part 10541 is as follows:  Brown Company has offered to sell Golden 5,000 units of Part 10541 for $19 a unit.Golden has determined that two thirds of the fixed manufacturing overhead will continue even if Part 10541 is purchased from Brown.Assume that direct labour is an avoidable cost in this decision.To determine whether to accept Brown's offer,the relevant costs to Golden of manufacturing the parts internally are:

Quizplus · Accepted Answer

The relevant costs to Golden of manufacturing the parts internally are the variable manufacturing costs plus the portion of fixed manufacturing overhead that is not avoidable.

Variable manufacturing cost per unit = Direct materials + Direct labor + Variable factory overhead = $14 + $18 + $6 = $38

Total variable manufacturing cost for 5,000 units = 5,000 units x $38 per unit = $190,000

Portion of fixed manufacturing overhead that is not avoidable = Two thirds x Fixed overhead = (2/3) x $60,000 = $40,000

Total cost of manufacturing 5,000 units internally = Variable manufacturing cost + Portion of fixed overhead = $190,000 + $40,000 = $230,000

Since Brown is offering to sell 5,000 units of Part 10541 for $19 a unit, the cost of purchasing the units from Brown would be 5,000 units x $19 per unit = $95,000

Since the cost of purchasing the units from Brown is lower than the cost of manufacturing the units internally, Golden should accept Brown's offer and purchase the units externally. The relevant cost in this decision is therefore $80,000 (the cost of manufacturing internally minus the cost of purchasing externally).