Assume that a division of Bose makes an electronic component for its speakers. Its manufacturing process for the component is a highly automated part of a just-in-time production system. All labor is considered to be an overhead cost, and all overhead is regarded as fixed with respect to output volume.
Production costs for 100,000 units of the component are as follows:
Direct materials $300,000
Indirect labor $80,000
Allocated occupancy cost 40,000 150,000
Total cost $450,000
A small, local company has offered to supply the components at a price of $3.30 each. If the division discontinued its production of the component, it would save two-thirds of the supplies cost and $30,000 of indirect-labor cost. All other overhead costs would continue.
The division manager recently attended a seminar on cost behavior and learned about fixed and variable costs. He wants to continue to make the component because the variable cost of $3.00 is below the $3.30 bid.
1. Compute the relevant cost of (a) making and (b) purchasing the component. Which alternative is less costly and by how much?
2. What qualitative factors might influence the decision about whether to make or to buy the component?
1. (a) The relevant cost of making is the avoidable cost - the cost that we would save if the components are not made since these are the incremental costs incurred in making the component. The avoidable costs ...
The solution explains how to do a make or buy decision with calculations and a list of qualitative factors.