Problem 1 Make Buy Decision 10 Points Cost to Make Widget DM DL Variable Overhea

ID: 2581133 • Letter: P

Question

Problem 1 Make Buy Decision 10 Points Cost to Make Widget DM DL Variable Overhead Fixed Overhead 12.00 8.00 5.00 3.00 Total 28.00 We need 1,000 Widgets per year. We can buy the Widget for $27 each Fixed overhead is allocated expense and none would be eliminated if we buy the Widget. Differential cost to make A. List relevant costs per Widget for each alternative Make Widget Buy Widget B. Based on your numbers, would you make or buy the Widget? C. What would be the total difference to net income if you buy the 1,000 widgets instead of making them? D. What are some other non-financial factor to consider when buving over making the widget?

Explanation / Answer

Solution:

This is a question of relevant cost and irrelevant cost.

Relevant Cost is the cost which will incur in future and different under each alternative course of action. The following costs are considered as relevant cost:

- Direct material cost

- direct labor cost

- Variable manufacturing overhead

- Variable selling and administrative expenses

The above costs are the variable cost which will vary with the production volume. Hence these costs have both the characteristic of relevant cost i.e. it is a future cost and different under each alternative course of action.

Irrelevant cost is the cost which do not play any role in decision making. Irrelevant Cost is the SUNK Cost which has already been incurred and does not change whether company accept the order or reject the order. Since these fixed costs are already been incurred and does not change in any case whether company make or buy product.

A) Calculation of Relevant Cost for each alternative

Differential

Make

Buy

Cost to make

$12

($12)

($8)

Variable Overhead

($5)

Purchase Price

$27

Relevant Cost per Widget

$25

$27

B) It is recommended to MAKE Widget.

Since the price offered by the outside supplier is higher than making the widget.

C) The Total Different to Net Income would be = 1,000 Widget x Loss $2 = Decrease in Net Income $2,000

D) Other non-financial factor to consider when buying over making the widget

- Quality of the product

- Regularity of supply

- Timely supply

- Market demand of the product