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John Moffat.
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- March 3, 2019 at 2:24 pm #507273
A company wants to decide whether to make its material in house or whether to sub contract production to external supplier
Prodcution capacity 8000 unitsMaterial w x y z
Units require 4000 2000 3000 4000
V/cost in 8$ 12$ 9$ 10$
Fix/oh expe 5000 8000 6000 7000
Cost of exter 9$ 18$ 12$ 12$Fixed cost are fixed cash expenditure that would be saved if production of the material in house stopped entirely
If a decision is made solely on the basis of short term cost consideration what material should the company purchase externally
1.4000 units of w and 1000 units of z
2.4000 units of w and 4000 units of z
3.3000 units of y and 2000 units of z
4.1000 units of y and 4000 units of z
Why the answer in not 1
I thought the capacity is 8000 so they can make 3000 of z in house which is cheaper and 1000 externally because there is no capacityMarch 3, 2019 at 5:33 pm #507298Your answer would be correct were it not for the fact that the fixed overhead expenditure is saved for any products that are purchased entirely externally.
I assume that you found this question in the BPP Revision Kit, in which case you will see the full explanation in their answer.
It is only buying W externally that would result in an actual saving (it would cost 4,000 x $1 to buy externally, but they would save $5,000 in fixed costs, so by buying W externally they would save $1,000. Buying any of the others would result in a net extra cost, so they will definitely buy W externally.
That leaves 4,000 remaining capacity. If they make 3,000 of Z in house, then they will not save any fixed overheads. It is better to buy all 4,000 of Z externally because they will then save the fixed overheads and the extra cost will only be $1,000 (which is less than the extra cost of the other two products).
March 3, 2019 at 5:41 pm #507302Thank you sir, sometimes the answer in the revision kit seem so vague but now i understand
March 4, 2019 at 7:32 am #507346You are welcome 🙂
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