Accounting Assignment Help With Make or Buy Decision

1.8 Make or Buy Decision

A particular component used in the main product may be purchased or may be manufactured in its own factory by utilising the idle capacity of the existing facilities. In such make or buy decision, the marginal cost of manufacturing in the unit is compared with the purchase price from the market. If marginal cost is less than the purchase price and then the component should be manufactured in its own unit, otherwise it should be purchased from the market. Fixed expenses are not taken in the cost of manufacturing on the assumption that they have been already incurred; the additional cost involved is only variable cost.

Example:

XYZ Ltd. produces a variety of products and components. Their cost information and purchase prices are as follows:

X($) Y($) Z($)

Direct Material 12 4 2

Direct Labour 4 16 6

Variable Overhead 2 4 4

Fixed Cost 6 20 10

Bought out price 15 45 25

One of these products can be produced in the factory and rest two are to be bought from outside. Select the component which should be bought from outside?

Solution:

Comparative Cost Sheet

X($) Y($) Z($)

Direct Material 12 4 2

Direct Labour 4 16 6

Variable Overhead 2 4 4

Marginal Cost 18 24 12

Bought out price 15 45 25

Saving (--) or increase (+)--3 +21 +13

It is clear from the above statement that Y should be produced in its own unit as its marginal cost is much lower than the purchase price and other two components i.e., X and Z be purchased from the market.

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