Recher Corporation uses part Q89 in one of its products. The company's Accounting Department reports the following costs of producing the 8,900 units of the part that are needed every year. Per Unit
Direct materials $8.20
Direct labor $4.60
Variable overhead $9.10
Supervisor's salary $3.40
Depreciation of special equipment $2.90
Allocated general overhead $1.60

An outside supplier has offered to make the part and sell it to the company for $28.00 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company. If the outside supplier's offer were accepted, only $4,600 of these allocated general overhead costs would be avoided. In addition, the space used to produce part Q89 could be used to make more of one of the company's other products, generating an additional segment margin of $17,800 per year for that product.

Required:
Prepare a report that shows the financial impact.

Recher Corporation

Differential Analysis:

                                      Make           Buy          Difference

Total variable costs  $225,170    $249,200      ($24,030)

General overhead         4,600                                 4,600

Additional segment margin             (17,800)          17,800

Total costs              $229,770     $231,400          ($1,630)

Recher should continue making the part.  It will incur $1,630 additional cost to buy it from the outside supplier than making it in-house.

Explanation:

a) Data and Calculations:

Annual units of Q89 required = 8,900

                                                          Per Unit

Direct materials                                   $8.20

Direct labor                                         $4.60

Variable overhead                              $9.10

Supervisor's salary                             $3.40

Depreciation of special equipment  $2.90

Allocated general overhead              $1.60

Relevant costs:

Direct materials                                   $8.20

Direct labor                                         $4.60

Variable overhead                              $9.10

Supervisor's salary                             $3.40

Variable costs per unit                    $25.30

Total variable costs                           $225,170 (8,900 * $25.30)

Avoidable general overhead                 4,600

Total avoidable production costs = $229,770

Cost of purchasing from outside supplier = $249,200 (8,900 * $28.00)

less additional segment margin                          17,800

Net avoidable purchase costs                        $231,400

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