Make-or-buy decision Shown below is next year’s budget for the forming and finishing departments of Tooton Ltd. The departments manufacture three different types of component, which are incorporated into the output of the firm’s finished products.

The forming department is mechanized and employs only one grade of labour; the finishing department employs several grades of labour with differing hourly rates of pay.
Required:

(a) Calculate suitable overhead absorption rates for the forming and finishing departments for the next year and include a brief explanation for your choice of rates.

(b) Another firm has offered to supply next year’s budgeted quantities of the above components at the following prices:

Advise management whether it would be more economical to purchase any of the above components from the outside supplier. You must show your workings and, considering cost criteria only, clearly state any assumptions made or any aspects that may require further investigation.

(c) Critically consider the purpose of calculating production overhead absorption rates.

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Production (units) Prime cost ( per unit): Direct materials Forming department Direct labour Forming department Finishing department Manufacturing times Component A B 14,000 10,000 6,000 8 7 6 602 9 12 10 15 24 31 282 29 (hours per unit): Machining Forming department Direct labour Forming department Finishing department 23 Forming 4 3 2 department () 3 10 Finishing department () 42 Variable overheads 200,900 115,500 Fixed overheads 401,800 231,000 602,700 346,500 Machine time required and available 98,000 hours Labour hours required and available 82,000 hours 154,000 hours