Assume a company is considering buying 10,000 units of a component part rather than making them. A supplier has agreed to sell the company 10,000 units for a price of $41.50 per unit. The company’s accounting system reports the following costs of making the part:

Per Unit 10,000 Units per Year
Direct materials $ 16 $ 160,000
Direct labor 12 120,000
Variable manufacturing overhead 2 20,000
Fixed manufacturing overhead, traceable 8 80,000
Fixed manufacturing overhead, allocated 4 40,000
Total cost $ 42 $ 420,000

One-half of the traceable fixed manufacturing overhead relates to supervisory salaries and the remainder relates to depreciation of equipment with no salvage value. If the company chooses to buy this component part from a supplier, then the supervisor who oversees its production would be discharged. What is the financial advantage (disadvantage) of buying 10,000 units from the supplier?

Question

Assume a company is considering buying 10,000 units of a component part rather than making them. A supplier has agreed to sell the company 10,000 units for a price of $41.50 per unit. The company’s accounting system reports the following costs of making the part:

Per Unit	10,000 Units per Year
Direct materials	$ 16	$ 160,000
Direct labor	12	120,000
Variable manufacturing overhead	2	20,000
Fixed manufacturing overhead, traceable	8	80,000
Fixed manufacturing overhead, allocated	4	40,000
Total cost	$ 42	$ 420,000

One-half of the traceable fixed manufacturing overhead relates to supervisory salaries and the remainder relates to depreciation of equipment with no salvage value. If the company chooses to buy this component part from a supplier, then the supervisor who oversees its production would be discharged. What is the financial advantage (disadvantage) of buying 10,000 units from the supplier?

BlackTom AI · Accepted Answer

Relevant knowledge points and concepts:
- Only incremental (avoidable) costs should be compared when deciding to make or buy. Sunk costs and unavoidable fixed costs are irrelevant.
- Variable costs and any fixed costs that can be eliminated if production stops are avoidable.
- Depreciation with no salvage and allocated fixed overhead that will remain regardless are not avoidable.

Step-by-step reasoning and calculations:
1. Compute the total cost to buy:
   - Purchase price = $41.50 per unit × 10,000 units = $415,000.

2. Identify avoidable (relevant) costs if the company continues to make the part:
   - Direct materials = $160,000
   - Direct labor = $120,000
   - Variable manufacturing overhead = $20,000
   - Traceable fixed manufacturing overhead = $80,000 total. The problem states one-half relates to supervisory salaries and one-half to depreciation with no salvage. Only the supervisory salary portion is avoidable if production stops. Avoidable traceable fixed overhead = $80,000 × 1/2 = $40,000
   - Allocated fixed manufacturing overhead ($40,000) and the depreciation portion ($40,000) are unavoidable (sunk or will remain) and therefore irrelevant.

3. Sum avoidable costs of making:
   - Avoidable cost = 160,000 + 120,000 + 20,000 + 40,000 = $340,000.

4. Compare buy vs. make:
   - Cost to buy = $415,000
   - Cost to make (avoidable) = $340,000
   - Difference = $415,000 − $340,000 = $75,000.

Why the correct answer is correct:
- Buying costs $75,000 more than the avoidable cost of making. Thus, buying results in a $75,000 financial disadvantage.

Why other options are incorrect:
- $(40,000) or $(75,000) would indicate net savings (advantages) of $40,000 or $75,000; our calculation shows an increased cost, not savings.
- $150,000 could result from double-counting avoidable fixed costs or treating other fixed costs as avoidable; those treatments are incorrect given the depreciation and allocated overhead are unavoidable.

Conclusion:
Buying the 10,000 units from the supplier results in a financial disadvantage of $75,000, which matches the provided answer $75,000.

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Using the BAPE example above, the supplier gets back in touch with the company after being told that the company decided to continue manufacturing their t-shirts. The external supplier says that they can go cheaper and offer the t-shirts for $16. What should BAPE do?

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