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- This topic has 3 replies, 2 voices, and was last updated 3 years ago by John Moffat.
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- May 31, 2021 at 9:14 pm #622516
A company wants to decide whether to make its material in house on whether to subcontract production to an external supplier. In the past it has made for materials in house, but demand in the next year will exceed in-house production capacity of 8000 units. All materials are made on the same machines and required 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 4000 2000 3000 4000Variable cost $8 Per unit $12 per unit $9 per unit $10 per unit
of inhouseDirectly attributable $5000 $8000 $6000 $7000
fixed cost exp.Cost of external $9 per unit $18 per unit $12 per unit $12 per unit
purchaseDirectly attributable fixed costs are fixed cash expenditures that would be saved if production of the material of the material inhouse has stopped completely
If a decision is made entirely on the basis of short term cost considerations, what materials should the company purchase externally.
A-4000 units of W and 1000 units of Z(according to me)
B-4000 units of W and 4000 units of Z(according to BPP Revision Kit)
C-3000 units of Y and 2000 units of Z
D-1000 units of Y and 4000 units of Z
Sir it has B option, I understood how 4000 of W has come in ans as we made saving of 1000 when we buy externally but I’m not getting the point that how 4000 units of Z we should buy externally as it does not make any saving .June 1, 2021 at 8:27 am #622565Had it not been for the directly attributable fixed costs then your answer would have been correct.
However the problem is that if they buy 1,000 units of Z externally then they will have to pay an extra $2 per units (so extra cost of $2,000) and will not save any fixed costs of Z because they would still be making 3,000 internally and will therefore still have all of the fixed costs.
If, instead, they buy 4,000 units of Z externally (and therefore make none internally) then they will have to pay an extra $2 per unit (so extra cost of $8,000) but will save all of the fixed costs of $7,000. So the net extra cost is $1000 which is better than only buying 1,000 units externally and having an extra cost of $2,000.
June 1, 2021 at 8:55 am #622573Okay got it. Thank you
June 1, 2021 at 9:02 am #622581You are welcome 🙂
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