1. Cost incurred when making the 10,000 skis without the avoidable cost
Direct labour $35
Direct material cost $30
Total overhead cost $15
Total cost of production per skis $80
Therefore, the total cost of producing the expected volume of 10000 skis.
Total production costs = $800,000
Cost incurred when subcontracting
Avoidable Cost of producing one pair:
Direct labour (10% of 35) = $3.5
Add: Direct material (20% of 30) = $ 6
Add: Total overhead (10% of 15) = $ 1.5
Total production cost per skis = $11
The total variable cost avoided as a result of subcontracting = $11
Add; Avoidable total overhead cost which is obtained as total fixed variable per ski less fixed overhead per unit
Fixed overhead per unit = (100,000 fixed charge) / (10,000 units Expected volume to be produced)
= $10
Therefore, avoidable overhead cost per unit= $ ( 15 - 10)= $ 5
Total avoidable costs= 11+5
=$ 16 per ski
Thus the cost of subcontracting will be $ 80 less $ 16 giving a total of $64 per ski because of the avoidable costs. The Ski Pro Corporation should buy the bindings because of the higher value of avoidable cost which reduces the cost of production
2. The maximum purchase price acceptable to the Ski Pro Corporation for the bindings
Maximum purchase price acceptable to the Ski Pro Corporation for the bindings is determined by working out the total of the variable costs
The maximum purchase price = cost per ski made and bound times the expected volume
= 64 X 10,000
=$640,000
As worked out in part one above, the avoidable costs must be examined and factored out to help arrive at the maximum purchase price.
3. Compute total cost of making (per unit variable plus fixed overhead) for 12,500 pair.
Cost of making:
Direct labour $35
Direct material cost $30
Total overhead cost $15
Add: fixed overhead per unit increment = increment of $10000 in fixed cost divide by the increment in sales volume of 2500
=10,000
2500
= $ 4 per unit
Therefore total cost of making will be equal to $ 84
Cost of buying as a result of increment
The total avoided costs when the product is subcontracted will be
Direct labour (10% of 35) = $3.5
Add: Direct material (20% of 30) = $ 6
Add: Total overhead (10% of 15) = $ 1.5
Total production cost per skis = $11
Add: avoidable total overhead cost which is obtained as total fixed variable per ski less fixed overhead per unit
Fixed overhead per unit= 10,000 fixed charge increment
2500 units increment
= $4
Therefore, avoidable overhead cost per unit= $ (15 - 4) = $ 11
Total avoidable cost of fixed and current variable hence is $ 11 + $ 11= $ 22
The Ski Pro Corporation should buy the bindings because of the higher value of avoidable costs as shown in the above calculations.
There are many non quantifiable factors that Ski Pro Corporation should consider in addition to the economic factors calculated in the numbers above. For instance, the quality of the materials used in making the bindings by the subcontractor. This is to ensure that the quality is of the required standard to ensure the value for money paid.
Reference
Desired Profit in Units. Retrieved at http://www.accountingcoach.com/online-accounting-course/
The given Case Study
