Question

Snipe Company has been purchasing a component, Part Q, for $19.20 a unit. Snipe is currently operating at 70% of capacity and no significant increase in production is anticipated in the near future. The cost of manufacturing a unit of Part Q, determined by absorption costing methods, is estimated as follows:Direct materials $11.50Direct labor 4.50Variable factory overhead 1.12Fixed factory overhead 3.15Total $20.27Prepare a differential analysis report, dated March 12 of the current year, on the decision to make or buy Part Q.

Answer 1

Answer:

Differential  Cost Analysis on March 12

Relevant cost of production:             $

Direct material                                 11.50

Direct labou                                       4.50

Variable production overhead          1,12

Total relevant cost of production    17.12

Cost of buying from outside            19.20

Differential cost                                 2.08

The company is advised to make the component in-house in order to save $2.08 per unit

Explanation:

In this case, there is need to calculate the relevant cost of in-house production  by considering the direct material cost, direct labour cost and variable overhead. Then, we will determine the cost of buying from outside. Finally, we will compare the relevant cost of production with cost of buying from outside. The decision will be based on the lower of the two.