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The SP Company makes 40,000 motors to be used in the production of its sewing machines. The average cost per motor at this level of activity consists of:Direct Materials$5.50Direct Labour$5.60Variable Manufacturing Overhead$4.75Fixed Manufacturing Overhead$4.45Average cost per motor$20.30An outside supplier recently began producing a comparable motor that could be used in the sewing machine. The price offered to SP Company for this motor is $18. If SP Company decides not to make the motors, there would be no other use for the production facilities, and total fixed factory overhead costs would not change. What is the net advantage (disadvantage) of purchasing the motors from outside supplier rather than making them? Assume that direct labour is a variable cost in this company. Question 18Answera.$92,000 net advantageb.$86,000 net disadvantagec.$92,000 net disadvantaged.$86,000 net advantage

Question

The SP Company makes 40,000 motors to be used in the production of its sewing machines. The average cost per motor at this level of activity consists of:Direct Materials5.50DirectLabour5.50Direct Labour5.60Variable Manufacturing Overhead4.75FixedManufacturingOverhead4.75Fixed Manufacturing Overhead4.45Average cost per motor20.30Anoutsidesupplierrecentlybeganproducingacomparablemotorthatcouldbeusedinthesewingmachine.ThepriceofferedtoSPCompanyforthismotoris20.30An outside supplier recently began producing a comparable motor that could be used in the sewing machine. The price offered to SP Company for this motor is 18. If SP Company decides not to make the motors, there would be no other use for the production facilities, and total fixed factory overhead costs would not change. What is the net advantage (disadvantage) of purchasing the motors from outside supplier rather than making them? Assume that direct labour is a variable cost in this company. Question 18Answera.92,000netadvantageb.92,000 net advantageb.86,000 net disadvantagec.92,000netdisadvantaged.92,000 net disadvantaged.86,000 net advantage

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Solution

To calculate the net advantage or disadvantage of purchasing the motors from an outside supplier, we need to compare the cost of making the motors in-house to the cost of purchasing them.

The cost of making the motors in-house includes the variable costs (direct materials, direct labor, and variable manufacturing overhead) and the fixed manufacturing overhead. The total cost per motor is $20.30.

The cost of purchasing the motors from an outside supplier is $18.00 per motor.

However, the fixed manufacturing overhead would not change even if the company decides not to make the motors. Therefore, when comparing the costs, we should only consider the variable costs.

The variable cost per motor for in-house production is 5.50(directmaterials)+5.50 (direct materials) + 5.60 (direct labor) + 4.75(variablemanufacturingoverhead)=4.75 (variable manufacturing overhead) = 15.85.

So, the cost difference per motor is 15.85(in−houseproduction)−15.85 (in-house production) - 18.00 (outside supplier) = -2.15.Thismeansthecompanywouldsave2.15. This means the company would save 2.15 per motor if they purchase from the outside supplier.

Since the company makes 40,000 motors, the total net advantage of purchasing the motors from the outside supplier is 2.15∗40,000=2.15 * 40,000 = 86,000.

Therefore, the answer is d. $86,000 net advantage.

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