Cornerstone Exercise 17.1 (Algorithmic) Make-or-Buy Decision, Alternatives, Relevant Costs Each year, Basu Company produces 11,000 units of a component used in microwave ovens. An outside supplier has offered to supply the part for $1.24. The unit cost is: Direct materials $0.76 Direct labor 0.27 Variable overhead 0.09 Fixed overhead 2.75 Total unit cost $3.87 Required: 1. What are the alternatives for Basu Company? 2. Assume that none of the fixed cost is avoidable. List the relevant cost(s) of internal production. List the relevant cost(s) of external purchase. 3. Which alternative is more cost effective and by how much? by $ 4. What if $21,360 of fixed overhead is rental of equipment used only in production of the component that can be avoided if the component is purchased? Which alternative is more cost effective and by how much? by $
Cornerstone Exercise 17.1 (Algorithmic) Make-or-Buy Decision, Alternatives, Relevant Costs Each year, Basu Company produces 11,000 units of a component used in microwave ovens. An outside supplier has offered to supply the part for $1.24. The unit cost is: Direct materials $0.76 Direct labor 0.27 Variable overhead 0.09 Fixed overhead 2.75 Total unit cost $3.87 Required: 1. What are the alternatives for Basu Company? 2. Assume that none of the fixed cost is avoidable. List the relevant cost(s) of internal production. List the relevant cost(s) of external purchase. 3. Which alternative is more cost effective and by how much? by $ 4. What if $21,360 of fixed overhead is rental of equipment used only in production of the component that can be avoided if the component is purchased? Which alternative is more cost effective and by how much? by $
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Make-or-Buy Decisions
Organizations are often faced with a make-or-buy decision-adecision of whether to make or to buy components or services usedin making a product or providing a service. For example, a factorycan make a component for a product in-house or purchase it from anoutside supplier.
Example: Each year, Ingmar Company produces13,100 units of a component used in microwave ovens. An outsidesupplier has offered to supply the part for $1.28. The unit costis:
Round intermediate calculations to the nearest cent. Use roundedanswers in subsequent computations, if required.
| Direct materials | $0.75 |
| Direct labor | 0.25 |
| Variable overhead | 0.18 |
| Fixed overhead | 2.42 |
| Total unit cost | $3.60 |
The alternatives for Ingmar Company are: continue making thecomponent in-house, or purchasing the component from the outsidesupplier. Assuming that none of the fixed cost is avoidable,determine which alternative is more cost effective: - Select youranswer -Make the component in-housePurchase from the outsidesupplierItem 1 . If Ingmar accepts the offer to purchase from theoutside supplier, operating income will be $ - Select your answer-higherlowerItem 3 .
Now suppose that Ingmar Company rents machinery capable ofmaking 13,100 units of the component per year and the annual leasecost is $13,100 (this is included in the fixed overhead for thecomponent). The lease can be cancelled whenever Ingmar wantswithout penalty. The machinery lease cost is - Select your answer-relevantnot relevantItem 4 . Determine which alternative is morecost effective: - Select your answer -Make the componentin-housePurchase from the outside supplierItem 5 . If Ingmaraccepts the offer to purchase from the outside supplier, operatingincome will be $ - Select your answer -higherlowerItem 7 .
The make-or-buy decision may be more complex than either examplenoted above. However, the key idea is that relevant costs andbenefits must be distinguished from irrelevant costs and benefits.Therefore, no matter how many costs are involved, the analyst candetermine the overall quantitative impact of making versus buying.Finally, the qualitative factors must be considered. For example,perhaps Ingmar Company believes that it can do a higher quality jobthan the outside supplier. Then, even if it were less expensive topurchase outside, the company could continue to make the componentin-house. Or, perhaps Ingmar Company could use the freed up spaceand workers to make a new, potentially very profitable, product.Then the company might decide to outsource the component even if itappears in the short-run to be a more costly approach.
1)The opportunity cost ofmaking a component part in a factory with no excess capacity isthe:
net benefit foregone fromthe best alternative use of the capacity required. | |
total manufacturing costof the component. | |
fixed manufacturing costof the component. | |
variable manufacturingcost of the component. |
2) A company has astandard cost system in which fixed and variable manufacturingoverhead costs are applied to products on the basis of directlabor-hours. A fixed manufacturing overhead volume variance willnecessarily occur in a month in which there is a fixedmanufacturing overhead budget variance.
True | |
False | |
3) Todco planned toproduce 3,000 units of its single product, Teragram, duringNovember. The standard specifications for one unit of Teragraminclude six pounds of material at $0.30 per pound. Actualproduction in November was 3,100 units of Teragram. The accountantcomputed a favorable materials purchase price variance of $380 andan unfavorable materials quantity variance of $120. Based on thesevariances, one could conclude that:
more materials were usedthan were purchased. | |
more materials werepurchased than were used. | |
the actual usage ofmaterials was less than the standard allowed. | |
the actual cost ofmaterials was less than the standard cost. |
4)The cost of a resourcethat has no alternative use in a make or buy decision problem hasan opportunity cost of zero.
True | |
False |
5)An unfavorable directlabor efficiency variance could be caused by:
an unfavorable variableoverhead rate variance. | |
a favorable materialsquantity variance. | |
an unfavorable materialsquantity variance. | |
a favorable variableoverhead rate variance. |
6) The fixed manufacturingoverhead volume variance will be unfavorable if production volumeis less than sales volume.
True | |
False |
7) If by dropping aproduct a firm can avoid more in fixed costs than it loses incontribution margin, then the firm is better off economically ifthe product is dropped.
True | |
False |
8) Joint costs are notrelevant to the decision to sell a product at the split-off pointor to process the product further.
True | |
False |
9) When a company has aproduction constraint, the product with the highest contributionmargin per unit of the constrained resource should be given highestpriority.
True | |
False |
10) An avoidable cost is acost that can be eliminated (in whole or in part) as a result ofchoosing one alternative over another.
True | ||
False | ||
11) The Malcolm Companyuses a standard cost system in which manufacturing overhead costsare applied to products on the basis of standard direct labor-hours(DLHs). The standards call for 4 hours of direct labor per unitproduced. The following data pertain to the company's manufacturingoverhead for the month of July: | ||
Actual fixedmanufacturing overhead costs incurred | $28,460 | |
Denominatoractivity | 6,305 | DLHs |
Number ofunits produced | 3,000 | units |
Budgetvariance | $3,240 | Unfavorable |
The Fixed component ofthe predetermined overhead rate for June is: (Round your answer to 2 decimal places.) |
$4.00 | |
$4.77 | |
$4.51 | |
$4.11 |
