$680,000 includes $10 per unit in fixed costs for producing the ice-makers. Only $6 of the fixed cost is avoidable if Refrigerator Company does not manufacture the ice-makers. Therefore, the other $4 of the fixed cost is irrelevant because it will be there regardless of which decision is made. $440,000 is the variable cost to purchase the ice-makers minus the avoidable fixed cost of $6 × 20,000, or $120,000. Thus, the avoidable fixed cost has been added to the cost to manufacture (along with the irrelevant fixed cost) and also subtracted from the cost to purchase. It cannot be used as an adjustment to both. Furthermore, this answer does not consider the contribution margin that can be earned from manufacturing and selling filtration units if Refrigerator Company buys the ice-makers from Cool Compartments.
This is a differential analysis. In a differential analysis, we look only at costs that will be different between (or among, if more than one option is being considered) the options If Refrigerator Company manufactures the ice-makers, its differential costs (costs that will differ from the costs that they would incur if they buy the ice makers instead) will include the variable costs to manufacture the ice makers and the fixed costs that will be different because they have chosen to manufacture the ice makers. Those fixed costs are the avoidable fixed costs, i.e., the fixed costs that would not exist if they choose to buy the ice makers instead. The problem tells us that if they buy the units, $6 per unit of the fixed overhead associated with the manufacture of ice makers would be eliminated, so that is the avoidable fixed cost. The differential cost to make the part is: Variable cost: $24 × 20,000 $480,000 Avoidable fixed cost: $6 × 20,000 120,000 Total $600,000 If Refrigerator Company buys the ice makers, its differential cost will be the cost to buy the part reduced by any contribution margin that they can earn from manufacturing and selling the filtration units instead. The differential cost to buy the part is: Variable cost: $28 × 20,000 $560,000 Less: Contribution margin from sales of filtration units, $80,000 × (1 ? .60) ( 32,000 ) Total $528,000
This answer correctly subtracts the contribution margin that could be earned from the sales of the filtration units from the variable cost to buy the ice-makers in calculating the differential cost to buy them. However, in calculating the differential cost of producing the ice-makers, the variable cost to produce the filtration units ($80,000 × .60) is added to the variable cost and the avoidable fixed cost of producing the ice-makers, and that is incorrect.
This answer does not consider the contribution margin that can be earned from manufacturing and selling filtration units if Refrigerator Company buys the ice-makers from Cool Compartments.
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Cool Compartments Inc. has offered to sell 20,000 ice-makers to Refrigerator Company for $28 per unit. If Refrigerator accepts Cool Compartments' offer, the facilities used to manufacture ice-makers could be used to produce water filtration units. Revenues from the sale of water filtration units are estimated at $80,000, with variable costs amounting to 60% of sales. In addition, $6 per unit of the fixed overhead associated with the manufacture of ice-makers could be eliminated. For Refrigerator Company to determine themost appropriate action to take in this situation, the total relevant costs of make vs. buy, respectively, are