To Produce or Not to Produce?−−That Is the Question
A manufacturing plant consists of three departments: A, B, and C. Department A occupies 100 square meters in one corner of the plant. Product X is one of several products being produced in Department A. The daily production of Product X is 576 pieces. The cost accounting records show the following average daily production costs for Product X:
| $120.00 | (1 operator working 4 hours per day at $22.50/hr, including fringe benefits, plus a part-time foreman at $30 per day) | Direct labor |
| 86.40 | Direct material | |
| 82.00 | (at $0.82 per square meter of floor area) | Overhead |
| $288.40 | Total cost per day = |
The department foreman has recently learned about an outside company that sells Product X at $0.35 per piece. Accordingly, the foreman figured a cost per day of $0.35(576) = $201.60, resulting in a daily savings of $288.40−$201.60 = $86.80. Therefore, a proposal was submitted to the plant manager for shutting down the production line of Product X and buying it from the outside company.
However, after examining each component separately, the plant manager decided not to accept the foreman’s proposal based on the unit cost of Product X:
1. Direct labor: Because the foreman was supervising the manufacture of other products in Department A in addition to Product X, the only possible savings in labor would occur if the operator working 4 hours per day on Product X were not reassigned after this line is shut down. That is, a maximum savings of $90.00 per day would result.
2. Materials: The maximum savings on direct material will be $86.40. However, this figure could be lower if some of the material for Product X is obtained from scrap of another product.
3. Overhead: Because other products are made in Department A, no reduction in total floor space requirements will probably occur. Therefore, no reduction in overhead costs will result from discontinuing Product X. It has been estimated that there will be daily savings in the variable overhead costs traceable to Product X of about $3.00 due to a reduction in power costs and in insurance premiums.