Industrial Machines Limited is able to rent all idle capacity for Rs. 5,00,000 per month.

  If the
Company decides to purchase the 10 units of Part No. T305 from Hydraulic Company, what will be
the effect on its profitability? Support your answer with the necessary calculations.

Customer-Profitability Analysis is the analysis of revenue earned, cost incurred and thereby how
much profit earned from different customers.
Answer: The total cost to manufacture one unit of Part No. T305 made by Industrial Machines
Limited is INR 424000.

Direct Material 20000

Material Handling 4000
Direct Labour 160000
Manufacturing overhead 240000
Total Cost 424000
The Industrial Machines Limited’s annual manufacturing overhead budget is two-thirds fixed.
So the Fixed Overhead is 2/3 of 240000 = INR 160000 

Total Fixed Overhead Cost Variance

= Absorbed fixed overheads -Actual fixed overheads
= 424000 -160000
=264000
The total cost to buy one unit of Part No. T305 made by Hydraulic Company is INR 360000

Unit Price 300000

Material Handling 60000
Total Cost 360000
So,
T305 If Amount
Buy 360000
Make 264000
Difference 96000
Difference for 10 units 960000
The total cost to be incurred is INR 960000
The rent from all idle capacity is INR 500000

The difference is INR 460000/-

There will be effect on its profitability, if the Industrial Machines Ltd decides to purchase the 10 units
of Part No. T305 from Hydraulic Company, since the total cost will not be incurred . Also company’s
monthly cost will be increased by INR 4,60,00/-.