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PERMALINO - Learning Activity 17 - Make or Buy Decision

The document discusses whether a company, Esber, should make or buy a component part. It provides the relevant costs of making the parts using idle capacity versus buying them from a supplier. The summary is: - Esber has idle capacity and needs 20,000 parts that take 0.5 hours each to make - The relevant unit cost to make the parts is Php 42.26 - The total relevant cost to make the parts is Php 845,200 - The total cost to buy the parts from the supplier is Php 900,000 - The differential cost of buying versus making is Php 54,800 - Esber should make the parts since the cost of making

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360 views3 pages

PERMALINO - Learning Activity 17 - Make or Buy Decision

The document discusses whether a company, Esber, should make or buy a component part. It provides the relevant costs of making the parts using idle capacity versus buying them from a supplier. The summary is: - Esber has idle capacity and needs 20,000 parts that take 0.5 hours each to make - The relevant unit cost to make the parts is Php 42.26 - The total relevant cost to make the parts is Php 845,200 - The total cost to buy the parts from the supplier is Php 900,000 - The differential cost of buying versus making is Php 54,800 - Esber should make the parts since the cost of making

Uploaded by

Ara Joyce Permalino
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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MANAGEMENT ACCOUNTING & CONTROL

SHORT TERM NON-ROUTINE DECISIONS

Learning Activity 17. Make or Buy

Esber Company has 15,000 hours of idle capacity. They need 20,000 units of a
component part used in its product lines. It is estimated that each unit will take one-half
machine hour for production. The following information is available:

Cost to make the parts:

Materials Php 14
Direct Labor 18
Factory Overhead (75% of DL/unit)
Variable factory overhead (40% of factory ovh/unit)

Cost to buy the parts per unit from the supplier Php 45

If Esber Company buys the parts rather than producing them, it will save 60% of fixed
overhead cost per unit.

Required:

1. Determine the relevant unit costs.


Relevant Unit Cost = 42.26 per unit
2. Determine the relevant total costs and differential costs.
Total Relevant Cost = 845,200
Differential Cost = 54,800
3. Should Esber Company manufacture the parts, or should it buy them from the outside
supplier?
Given the numbers computed, the company should continue to MAKE THE
PARTS because they will be able to save 54,800. The cost of making (845,200) is
lesser than the cost of buying (900,000)

Solution:

Given:
15,000 Machine hours
20,000 units
0.5 Machine Hours per unit

Step 1: COMPUTATION OF FACTORY OVERHEAD


“75% of direct labor cost per unit”

Factory Overhead per unit = Direct Labor Cost per unit x 75%
= 18 x 75%
= 13.50
Step 2: IDENTIFY THE VARIABLE AND FIXED COMPONENT OF OVERHEAD

“Variable factory overhead (40% of factory overhead unit)”


If variable is 40% of Overhead per Unit,
Then the remaining 60% is the fixed portion

Factory Overhead:
Variable = 13.5 x 40% = 5.40
Fixed = 13.5 x 60% = 8.10
Total 13.50

Step 3: IDENTIFY THE AVOIDABLE PORTION OF THE FIXED OVERHEAD

Fixed Factory Overhead per Unit = 8.10


“If the Esber Company buys the parts rather than producing them,
it will save 60% of fixed overhead cost per unit”

Avoidable Fixed Cost = Fixed Factory Overhead x 60%


= 8.10 x 60%
Avoidable Fixed Cost = 4.86

Step 4: DETERMINE THE RELEVANT UNIT COST

Generally, all variable cost are relevant while only those avoidable fixed cost are
Relevant.

Relevant? Relevant Cost Not Relevant


Direct Materials YES 14.00
Direct Labor YES 18.00
Factory Overhead
- Variable YES 5.40
- Fixed:
- Avoidable YES 4.86
- Not Avoidable NO 3.24
Total 42.26 3.24

RELEVANT UNIT COST = 42.26


Step 5: COMPUTE THE RELEVANT TOTAL COST AND DIFFERENTIAL COST

Cost to Make:
Relevant Unit Cost 42.26
X No. of Units needed 20,000
Total Relevant Cost to Make 845,200

Cost to Buy:
Supplier’s Price 45
X No. of Units needed 20,000
Total Cost to Buy 900,000

DIFFERENTIAL COST = Total Cost to Buy – Total Relevant Cost to Make


= 900,000 – 845,200
= 54,800

TOTAL RELEVANT COST 845,200


DIFFERENTIAL COST 54,800

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