Case Scenario:
Cincinnati Flow Technology (CFT) has purchased 10,000 pumps annually from Kobec, Inc. Because the price keeps increasing and reached $102.00 per unit last year, CFT’s management has asked for an estimate of the cost of manufacturing the pump in CFT’s facilities. CFT makes stampings and castings and has little experience with products requiring assembly.
The engineering, manufacturing, and accounting departments have prepared a report for management which includes the following estimate for an assembly run of 10,000 pumps. Additional production employees would be hired to manufacture the pumps but no additional equipment, space, or supervision would be needed.
The report states that total costs for 10,000 units are estimated at $1,435,500 or $143.55 per unit. The current purchase price is $102.00 per unit, so the report recommends continued purchase of the product.
Components (outside purchases) .............................................................................................. $ 180,000
Assembly labor* .......................................................................................................................... 450,000
Manufacturing overhead† ............................................................................................................. 675,000
General and administrative overhead‡ ..........................................................................................130,500
Total costs ................................................................................................................................ $1,435,500
* Assembly labor consists of hourly production workers.
Manufacturing overhead is applied to products on a direct-labor-dollar basis. Variable-overhead costs vary closely with direct-labor dollars.
Fixed overhead ....................................................................................... 50% of direct-labor dollars
Variable overhead ................................................................................... 100% of direct-labor dollars
‡General and administrative overhead is applied at 10 percent of the total cost of material (or components), assembly labor, and manufacturing overhead.
Required: Were the analysis prepared by Cincinnati Flow Technology’s engineering, manufacturing, and accounting departments and their recommendation to continue purchasing the pumps correct?
Explain your answer and include any supporting calculations you consider necessary.