Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 51

Learning Curves (Appendix B)

Krylon Company purchases eight special tools annually from CO., Inc. The price of these tools has increased each year, reaching $100,000 per unit last year. Because the purchase price has increased significantly, Krylon management has asked for a cost estimate to produce the tools in its own facilities.

A team of employees from the engineering, manufacturing, and accounting departments has prepared a report for management that includes the following estimate to produce the first unit. Additional production employees will be hired to manufacture the tools. However, no additional equipment or space will be needed.

The report states that total incremental costs for the first unit are estimated to be $120,000, as shown here.

Materials	$40,000
Direct labor, consisting entirely of hourly production
workers (varies with production volume)		80,000

Overhead and administrative costs are not affected by producing this tool.

The current purchase price is $100,000 per unit, so the report recommends that Krylon continue to purchase the product from CO., Inc.

Required

Assume that Krylon could experience labor-cost improvements on the tool production consistent with an 80 percent learning curve. Should Krylon produce or purchase its annual requirement of eight tools? Explain your answer. (Note that the 80 percent learning rate coefficient is -0.3219.)

Step 1 of 3

?Krylon should produce the tool itself. With an 80 percent learning rate (learning rate coefficient of -0.3219), the average cost of a tool for 8 tools is $93,461, which is less than the supplier cost. This is shown in the table below, which is similar to Exhibit 5-21. (Note: rounding errors might lead to slight differences from the results reported below.)

Unit	Learning	Total	Average		Total
Produced	Factor1	Labor	Labor Cost	Materials	Average
(X)	(Y)	Cost2	Per Unit3	Cost	Cost
1	1.00	$  80,000.00	$80,000.00	$40,000.00	$120,000.00
2	0.80	144,001.25	72,000.62	40,000.00	112,000.62
3	0.70	200,171.28	66,723.76	40,000.00	106,723.76
4	0.64	251,373.27	62,843.32	40,000.00	102,843.32
5	0.60	299,026.41	59,805.28	40,000.00	99,805.28
6	0.56	343,963.31	57,327.22	40,000.00	97,327.22
7	0.53	386,724.81	55,246.40	40,000.00	95,246.40
8	0.51	427,687.20	53,460.90	40,000.00	93,460.90

1.?This is the ratio of the labor time it takes to produce unit X relative to the first unit and is equal to X-0.3219