make or buy decision in accounting

Question

Oxford Engineering manufactures small engines. The engines are sold to manufacturers who install them in such products as lawn mowers. The company currently manufactures all the parts used in these engines, but it is considering a proposal from Tidnish Electronics, a reliable supplier, to supply starter assembly units for $6.10 each.

The starter assembly is currently manufactured in Division 3 of Oxford Engineering. Last year, Division 3 manufactured 164,000 starter assemblies, but over the next several years, it is expected that 191,000 assemblies will be needed each year. Total costs related to the starter assembly for last year were as follows:

  Direct material$331,280  Direct labor$183,680  

Total overhead$820,000  Total$1,334,960

Further analysis of overhead revealed the following information:

1. $451,000 of total overhead was fixed.
2. $341,000 of the fixed overhead can be avoided if the starter assembly is purchased from the supplier.

Also, if the company buys the assembly from Tidnish, sales of another product can be increased, resulting in additional contribution margin of $35,000 with no additional fixed costs.

By how much will Oxford Engineering's total profits change if they decide to buy the starter assembly from Tidnish Electronics instead of making it themselves?   [Note: if the buy costs are less than the make costs, enter the difference as a positive number; if the buy costs are more than the make costs, enter the difference as a negative number.]

Answer 1

To determine whether Oxford Engineering should continue manufacturing the starter assembly or buy it from Tidnish Electronics, we need to compare the total costs of each option.

The total cost of manufacturing the starter assembly is:

Direct material + Direct labor + Total overhead = $331,280 + $183,680 + $820,000 = $1,334,960

If Oxford Engineering buys the starter assembly from Tidnish Electronics, the cost will be $6.10 per unit, and 191,000 units will be needed each year. Therefore, the total cost of buying the starter assembly will be:

Cost per unit x Number of units needed per year = $6.10 x 191,000 = $1,166,100

The difference in total costs between making and buying the starter assembly is:

Total cost of making - Total cost of buying = $1,334,960 - $1,166,100 = $168,860

However, we also need to consider the $341,000 of fixed overhead that can be avoided if Oxford Engineering buys the starter assembly from Tidnish Electronics. In addition, the company can increase sales of another product, resulting in additional contribution margin of $35,000 with no additional fixed costs.

Therefore, the net difference in total profits if Oxford Engineering decides to buy the starter assembly from Tidnish Electronics instead of making it themselves is:

Savings in fixed overhead + Additional contribution margin - Difference in total costs = $341,000 + $35,000 - $168,860 = $207,140

Therefore, Oxford Engineering's total profits will increase by $207,140 if they decide to buy the starter assembly from Tidnish Electronics instead of making it themselves.