E25-18 Making outsourcing decisions Cool Systems manufactures an optical switch that it uses in its final product. The switch has the following manufacturing costs per unit: Direct materials $5.00 Direct labor 3.00 Variable overhead 6.00 Fixed overhead 7.00 Manufacturing product cost $21.00 Another company has offered to sell Cool Systems the switch for $15.00 per unit. If Cool Systems buys the switch from the outside supplier, the idle manufacturing facilities cannot be used for any other purpose, yet none of the fixed costs are avoidable. Prepare an outsourcing analysis to determine whether Cool Systems should make or buy the switch. Miller-Nobles, Tracie. Horngren's Accounting (p. 1447). Pearson Education. Kindle Edition.

From a cost savings perspective the switch should be made in-house

Explanation:

In deciding whether Cool Systems should make or buy the switch, we calculate the relevant applicable to both situations, then compare t see which option saves costs.

The cost of making the switch is calculated thus:

Direct materials per unit $5

Direct labor $3

Variable overhead $6

Total relevant cost $14

The cost of purchasing the switch from another supplier is $15

From the above analysis, it is preferable to make the switch in-house as that option saves $1 ($15-$14) per switch.

However, it might be that we need to look beyond cost savings sometimes, purchasing the switch from another supplier might be viable if the quality of the outside switch is better or that the outside supplier can deliver in timely fashion.