Question

Paxton Company can produce a component of its product that incurs the following costs per unit: direct materials, $10.90; direct labor, $14.90, variable overhead $3.90 and fixed overhead, $8.90. An outside supplier has offered to sell the product to Paxton for $38.60. Compute the net incremental cost or savings of buying the component.

Answer 1

Answer:

$ 8.9

Explanation:

Given:

Direct materials cost = $ 10.90

Direct labor = $ 14.90

Variable overhead cost = $ 3.90

Fixed overhead cost = $ 8.90

Selling price offered for the product = $ 38.60

Net incremental cost = Offered selling price - ( Direct materials cost + Direct labor + Variable overhead cost )

The fixed cost is not included because, it will be incurred whether the offer is accepted or not.

therefore,

Net incremental cost = $ 38.60 - ( $ 10.90 + $ 14.90 + $ 3.90 )

or

The net incremental cost = $ 8.9

Answer 2

Answer:

There is no incremental cost or savings in buying the equipment in case fixed cost is avoidable, if fixed cost is not avoidable then there will be incremental cost of $8.90 fixed per unit in case of buying.

Explanation:

The direct cost associated with the product, is avoidable in case if the product is not produced, but fixed cost is sometimes avoidable and sometimes not avoidable, therefore,

while taking the decision whether to purchase the product from outside or not, if considering fixed cost only if it is avoidable,

Total cost of production per unit = $10.90 + $14.90 + $3.90 + $8.90 = $38.60

Since the total cost of producing the product and buying is same both are equivalent as no incremental profit or gain has been incurred,

In case if fixed cost is not avoidable then product should only be manufactured as the fixed cost in that case would be additional to buying cost of $38.60 per unit.

Therefore, on conclusion

There is no incremental cost or savings in buying the equipment in case fixed cost is avoidable, if fixed cost is not avoidable then there will be incremental cost of $8.90 fixed per unit in case of buying.