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Dear Mr Moffat
Thank you for your lectures, they are really helpful.
Can you please explain the question below (it is Q122 in BPP latest revision kit)
Q) A company wants to decide whether to make its materials in-house or whether to sub-contract production to an external supplier. In the past it has made four materials in-house, but demand in the next year will exceed in-house production capacity of 8,000 units. All four materials are made on the same machines and require the same machine time per unit: machine time is the limiting production factor.
The following information is available.
Material W X Y Z
Units required 4,000 2,000 3,000 4,000
Variable cost of
in-house manufacture $8p.u $12p.u $9p.u $10p.u
Directy attributable
fixed cost expenditure $5,000 $8,000 $6,000 $7,000
Cost of external
purchase $9p.u $18p.u $12p.u $12p.uIf a decision is made solely on the basis of short-term cost considerations, what materials should the company purchase externally?
A 4,000 units of W and 1,000 units of Z
B 4,000 units of W and 4,000 units of Z
C 3,000 units of Y and 2,000 units of Z
D 1,000 units of Y and 4,000 units of Z
Sir, please explain this question, I havent been able to understand how 4,000 units of Z needs to be purchased externally. I have been struggling for few days in this question.
Thank you, Sir.
In future you do not need to type out questions in full. I have the BPP Revision Kit and all past exam questions, so you only need to tell me which question 🙂
The problem here is the directly attributable fixed costs.
If these fixed costs did not exist, then it would be easy and we would make X in-house because it would give the biggest saving per unit against the purchase price ($6). However, we only need 2,000 units and so for the remaining 6,000 of capacity we would then also make the ‘next best’ which would be 3,000 units of Y (saving $3 per unit). That would leave us making 3,000 units of Z (saving $2 per unit).
However, the problem is that if we do that, then we will still incur the directly attributable fixed overhead for X, for Y, and also all $7,000 for Z because even though we would only be producing 3,000 units internally we would still have the full fixed costs. These fixed costs are only saved if we produce no units of Z internally.
So what the answer has done is calculated for each of the 4 products what the net extra cost would be if we bought externally instead of producing ourselves (i.e. the extra purchase price less the fixed costs saved if we are producing none internally). W is the best because buying externally saves us a net $1,000. However we then need to decide what we should produce internally given that we are able to produce a maximum 8,000 units. We cannot produce all of the other three internally because they total 9,000, and therefore some would have to be bought externally. But remember that buying any externally will only save us the fixed overheads if all of that product was bought externally (producing any internally will still incur the full fixed costs).
Buying all of Z externally will cost us a net $1,000, whereas buying X and/or Y externally would mean that some Z’s would have to be produced internally so none of the fixed costs of Z would be saved.
dear tutor, when in a question there are general fixed costs and directly attributable fixed costs does that mean that directly attributable is a part of general fixed cost, or are they different?
I do not think that you can have been watching my free lectures, because I explain this in more than one lecture 🙂
General fixed costs are shared between the various products and will still be payable whether or not all the products are produced.
Directly attributable fixed costs are only incurred if the particular product is produced.
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