Arapahoe Manufacturing, Inc., has just received an offer from a supplier to provide 10,000 units of a component used in its main product. The component is a gear that is currently produced internally. The supplier has offered to sell the gear for $172 per unit. Arapahoe is currently using a functional, unit-based cost system that assigns overhead to jobs on the ba¬

sis of direct labor hours. The estimated functional-based full cost of producing the gear is given below:

Prior to making a decision, the company's CEO commissioned a special study to see whether there would be any decrease in the fixed overhead costs. The results of the study revealed the following:
3 setups—$4,200 each (The setups would be avoided and total spending could be reduced by $4,200 per setup.) „ .
One less inspector needed, $26,500. K y"
One less material handler needed, $24,000. '''
Engineering work: 615 hours, $20/hr. (Although the work decreases by 615 hours, the engineer assigned to the gear line also spends time on other products.)
Required:
1. Ignore the special study and determine whether the gear should be produced internally or purchased from the supplier. \'d 2. Now, using the special study data, repeat the analysis.
3. Discuss the qualitative factors that would affect the decision, including strategic impli¬
cations.
4. After reviewing the special study, the controller made the following remark: "This study ignores the additional activity demands that purchasing would cause. Eor example, al¬
though the demand for inspecting the part on the production floor decreases, will we not have a need to inspect the incoming parts in the receiving area? Will we actually save any inspection costs?" Is the controller right? Would this problem be avoided if Arapahoe had an activity-based costing system in place?

Transcribed Image Text:

Direct materials $135 Direct labor 15 Variable overhead Fixed overhead 20 55