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OUTCOME 2B(week 4)

By Norman Gordon,2014-06-28 20:43
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OUTCOME 2B(week 4)

    Make or Buy Decisions

    Example 2.10 P126

    Bravo Limited ?

    Estimated costs of making component AA1

    Materials 14,000

    Labour 12,000

    Variable Overheads 3,000

    Fixed Overhead (direct). These costs will stop if we buy 6,000

    component AA1 from Delta Limited.

    Fixed Overhead (common). These costs will continue if 12.000

    we buy component AA1 from Delta Limited.

    TOTAL COST 47,000

    Solution to Example 2.10

    ; We should never make the comparison of the ?47,000 total cost

    of manufacturing AA1 with the buying-in cost of ?40,000.

    ; This is because Bravo Limited have allocated ?12,000 common

    fixed costs which will continue, even if the manufacture of

    component AA1 should cease. All other costs, totalling ?35,000

    might be saved, depending on whether labour can be deployed

    elsewhere.

    Bravo Limited ?

    Revised estimated costs of making component AA1

    To allow comparison with quote from Delta Limited

    Materials 14,000 Labour 12,000 Variable Overheads 3,000 Fixed Overhead (direct). These costs will stop if we buy 6,000 component AA1 from Delta Limited.

    TOTAL COST 35,000 ; A comparison of this ?35,000 avoidable cost with the offer

    of ?40,000 is the correct one to make. In this example, it is

    cheaper for Bravo Limited to continue to make component

    AA1.

    ; This conclusion might well be different if we are working to

    full capacity, when buying in the component would release

    capacity to do other work.

    Example 2.11

    Solution to Example2.11

    ? Bravo Limited

    Revised Estimated Costs of Making Component AA1

    To Allow Comparison with Quote from Delta Limited

    Materials 14,000

    Labour contribution from alternative work 19,000

    Variable Overheads 3,000

    6,000 Fixed Overhead (direct). These costs will stop if we buy

    component AA1 from Delta Limited.

    TOTAL COST 42,000

    It can be seen that the Opportunity Cost for labour increases our avoidable costs to ?42,000, which is now greater than the ?40,000 offered by Delta Limited. Whether this ?2,000 saving is sufficient to warrant buying-in is debatable, when other factors are considered.

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