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GR manufactures two products for which details are shown below:
Product X Y
Selling price per unit $66 $100
Variable cost per unit $42 $75
Fixed cost per unit $30 $34
Skilled labour per unit 0.4 hr 0.5 hr
Maximum quarterly demand 5000 5000
For the current period, GR is experiencing a shortage of skilled labour, of which only 1,000 hours will be available. If products are not produced internally they can be bought in at prices of $50 for X and $80 for Y.
How many units of Product Y should be produced in the period?
(a) 0 units
(b) 500 units
(c) 2,000 units
(d) 2,500 units
Answer is A.
In answer, it is not subtracting Fixed cost (it was only subtracting variable cost from inhouse cost to see how much we are getting extra cost to buy which gave him $8 for Product x and $5 for product Y) and then he found Differential cost per limiting factor.
But Sir the problem is that I also subtracted fixed cost and then differential cost per limiting factor which gave $55 and $58.)
Please help sir.And sir, what does differential cost per limiting factor describes or what does it means?
When making production decisions fixed costs should be ignored: they are fixed and constant whatever the decision. (The only exception would be if some fixed costs could be avoided by closing part of a factory…..then those fixed costs have become variable.) Contribution, not profit is used in decision.
If X s bought in then its contribution falls by 8/unit. For Y, the reduction is 5/unit. If both products took the same time to make, it is plain you would only buy in Y and make none as all production time would be dedicated to X.
However, the units take different times and you need to look at the cost per labour hour of buying instead of making.
X 8/ 0.4 = 20
Y 5/ 0.5 = 10So the cost per hour saved by buying is still lower for Y. Don’t make any Y.
Sir, no matter we subcontract or in-house product the fixed cost are not part of decision making until a fixed cost which is incurred direct consequence of making would have been subtracted for decision making?
Am I right sir?Whether all goods are made or some are bought in, the same total fixed costs are included.
The concept of fixed cost per unit is used to calculate a unit’s total absorption cost. It does no mean that making an additional unit causes more fixed costs.
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