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Hi all the students of F2
some one from Opentuition send me this question to solve.
and I find it quit challenging for F2 students.Here is the question:-
XYZ Company has offered to sell B Company 5000 units of product for $27 each, if B Company accepts the offer some of the facilities presently used to manufacture this product could be used to help with the manufacture of another product, thus saving $.40000 in relevant cost in its manufacture and eliminating $3 per unit of the fixed factory overhead applied to the earlier product.
Company’s cost of manufacture
Costs per unit for 5000 units are;
Direct material
$2
Direct labour
$12
Variable factory overhead
$5
Fixed factory overhead
$7
Total unit cost
$26***Should the company make or buy the product?
Answer:-
The make or buy decision will be taken based on the lower ofRelevant cost of making the product
Or
Relevant cost of buying the productLet’s calculate the relevant cost of making and buying the product
Method 1:
Per unit
Total
Relevant cost of buying
$27
(27 X 5000)
$135000
Saving in relevant cost
($8)
($ 40000) ($40000/500=$8)
Saving in Fixed cost
($3)
(5000 X 3)
($ 15000)
______________________________________________________________
Relevant cost of Buying
$16
$ 80000……………(i)
______________________________________________________________Relevant cost of Making
Direct Material
$ 2
(5000 X 2)
$10000
Direct labour
$12
(5000 X 12)
$60000
Variable overhead
$ 5
(5000 X 5)
$25000
_______________________________________________________________
Relevant cost of making
$19
$95000……………(ii)
_______________________________________________________________
So saving on buying
$3
$ 15000 ….….(ii less i)
===============================================================***You can treat the saving of relevant cost (40000/5000=8) and saving on attributable fixed cost $3 as a reduction on your buying cost. Because if you buy the product you will be able to save this cost thus you will be able recover some portion of buying cost by saving some relevant cost.
Method 2:-
You can also treat the saving of relevant cost $8 and saving of fixed cost $3 as a relevant cost of making. Because if you make the product you will not be able to save this cost using the facilities in another product. Thus increase in relevant cost of making.Relevant cost of Making –Per unit
Total
Direct Material
$2
(5000 X 2
$10000
Direct labour
$12
(5000 X 12)
$60000
Variable overhead
$5
(5000 X 5)
$25000
Saving in relevant cost
$8
$40000-($40000/500=$8)
Saving in Fixed cost
$3
(5000 X 3)
$15000
_______________________________________________________________
Relevant cost of making –$30
$150000………..(i)
_______________________________________________________________
Relevent cost of buying—$27
(27 X 50000)
$135000…..(ii)
_______________________________________________________________
Saving by buying
$3
$15000…..(i less ii)
===============================================================*** In method 2, question stated that the fixed factory overhead is $7. But fixed cost is not a relevant cost unless it’s directly attributable to the product. If you look at the beginning of the question, it has been told that if the company buy the product company will be able to eliminate $3 of fixed factory overhead. This is the indicator of the fixed cost which is directly attributable the product. Thus $3 of this $7 is relevant other ($7 less $3) =$4 is not relevant.
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wow! very good!…I have to spend sometime on relevant costing..have not gotten there yet right know having challenges with variances
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@yvettepbabb variances analysis are not difficult at all, most of the time is standard compare with actual except the case of fixed overhead only
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my problem more so capacity what am I looking for in the question? expenditure etc..
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