Henry Horticultural, Ltd., is a leading producer of greenhouse irrigation systems. Currently, the...

Question:

Henry Horticultural, Ltd., is a leading producer of greenhouse irrigation systems. Currently, the company manufactures the timer unit used in each of its systems.

Based on an annual production of 40,520 timers, the company has calculated the following unit costs.

Direct fixed costs include supervisory and clerical salaries and equipment depreciation.

Direct materials $12
Direct labor 7
Variable manufacturing overhead 4
Direct fixed manufacturing overhead 10 (30% salaries, 70% depreciation)
Allocated fixed manufacturing overhead 8
Total unit cost $41

Talbert Time Pieces has offered to provide the timer units to Henry at a price of $36 per unit. If Henry accepts the offer, the current timer unit supervisory and clerical staff will be laid off.

a) Calculate the total relevant cost to make or buy the timer units.

b) Assume that if Henry Horticultural accepts Talbert's offer, the company can use the freed-up manufacturing facilities to manufacture a new line of growing lights. The company estimates it can sell 99,360 of the new lights each year at a price of $12. Variable costs of the lights are expected to be $9 per unit. The timer unit supervisory and clerical staff would be transferred to this new product line.

Calculate the total relevant cost to make the timer units and the net cost if they accept Talbert's offer.

Relevant Cost:

The proposal (special offer or outsourcing offer) is accepted or rejected based on the net relevant cost involved in the offer. If the proposal or offer provides a low net relevant cost per unit only then the offer is accepted. The opportunity is included in the relevant cost.

Answer and Explanation:

Requirement (a) and (b):

(a) Computation for total relevant cost
Buy Make
Particulars Amount
Purchase cost $36
Direct materials -$12 $12
Direct labor -$7 $7
Variable manufacturing overhead -$4 $4
Direct fixed manufacturing overhead ($10 x 30%) $0 $3
Savings in the fixed cost -$3
Total relevant cost $10 $26
(b) Evaluation of purchase offer
Particulars Amount
Relevant Purhcase Cost ($10 + $3) x 40,520 $526,760
Less: Incremental Profit ($12 - $9) x 99,360 -$298,080
Net Relevant Purhcase Cost $228,680
Cost Per Unit ($228,680/40,520) $5.64


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