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Hi, I am confused with the question, could you please help.
P Limited is considering whether to continue making a component or buy it from an outside supplier. It uses 12,000 of the components each year.
The internal manufacturing cost comprises:
$/unit
Direct materials 3.00
Direct labour 4.00
Variable overhead 1.00
Specific fixed cost 2.50
Other fixed costs 2.00
–––––
12.50
–––––If the direct labour were not used to manufacture the component, it would be used to increase the production of another item for which there is unlimited demand. This other item has a contribution of $10.00 per unit but requires $8.00 of labour per unit.
The maximum price per component at which buying is preferable to internal manufacture is?
This is actually a standard relevant costing question.
The relevant cost of making internally (and therefore the maximum price at which buying externally is preferable) is the total of the variable costs and the specific fixed cost, replying the labour cost ($4) with the labour cost plus the lost contribution per unit.
Since each unit of the other item requires $8 of labour, it is equivalent to 2 units ($8 / $4) of the component, and therefore the lost contribution per component is 10/2 = $5.
Therefore the total relevant cost of the labour is $4 + $5 = $9.For a full explanation with examples you should watch our free lecture on relevant costing.
Our lectures are a complete course for Paper F5 and cover everything needed to be able to pass the exam well.
sir i need the concept of topic when to buy the product or make the product and how to take these decisions ?
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