ROBBER CO (JUNE 2012 question )

So use relevant costs when evaluating the overall decision and include fixed costs if they are avoidable. Use variable costs only when dealing with limited resources to assess the marginal cost of production.

1. Relevant Costs: These are costs that will be directly affected by the decision at hand. When considering whether to manufacture in-house or buy from an external supplier, you should include all relevant costs, which can encompass both variable costs and avoidable fixed costs. This is particularly important when you are evaluating the total cost of production versus the cost of purchasing externally.

2. Variable Costs Only: In scenarios where there are scarce resources, such as limited labor or machine time, the focus shifts to variable costs. This is because the decision may hinge on the marginal cost of producing one more unit versus the cost of buying it. In such cases, you compare only the variable costs of making the product in-house against the external purchase price to determine the most cost-effective option.

In the Robber Co example, part A included all relevant costs because it was assessing the overall cost of manufacturing versus buying. In part B, where labour was a scarce resource, the analysis focused solely on variable costs to determine which products to prioritise for in-house production versus outsourcing.