Ex 25-7 Make-or-buy decision

Eclipse Computer Company has been purchasing carrying cases for its portable computers at a delivered cost of $65 per unit. The company, which is currently operating below full capacity, charges factory overhead to production at the rate of 40% of direct labor cost. The fully absorbed unit costs to produce comparable carrying cases are expected

to be as follows:

Direct materials                          $30

Direct labor                               25

Factory overhead (40% of direct labor)     10

Total cost per unit                       $65

If Eclipse Computer Company manufactures the carrying cases, fixed factory overhead costs will not increase and variable factory overhead costs associated with the cases are expected to be 15% of the direct labor costs.

a. Prepare a differential analysis, dated July 19, 2014, to determine whether the company should make (Alternative 1) or buy (Alternative 2) the carrying case.

b.  On the basis of the data presented, would it be advisable to make the carrying cases or to continue buying them? Explain.

Answer:

a. Differential Analysis 

Make Carrying Case (Alt. 1) or Buy Carrying Case (Alt. 2) 

July 19, 2014 

 Make 

Carrying 

Case 

(Alternative 1) 

Carrying 

(Alternative 2) 

Costs:    

Purchase price $  0.00 –$65.00 –$65.00 

Direct materials per unit –30.00 0.00 30.00 

Direct labor per unit –25.00 0.00 25.00 

Variable factory overhead per unit –3.751

 F

ixed factory overhead per unit –6.252

 I

ncome (Loss) –$65.00 –$71.25 –$  6.25 

    

$25.00 × 15% 

$10.00 – $3.75 

b. Assuming there were no better alternative uses for the spare capacity, it would 

be advisable to manufacture the carrying cases because the cost savings would 

be $6.25 per unit. Fixed factory overhead is irrelevant, since it will continue 

whether the carrying cases are purchased or manufactured.