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Homework answers / question archive / Company A produces a component used in the production of one of the company's main products
Company A produces a component used in the production of one of the company's main products. The costs are budgeted as follows: Amount per unit (R) Amount per 5 000 units (R) Materials 25 000 Labour 75 000 Variable overhead 50 000 Depreciation 20 000 Allocated general overhead 60 000 Total cost 230 000 15 10 12 46 The components can be purchased from an outside supplier at a cost of R35 per unit. Required: 2.3.1 Determine whether the company should make or buy the component. In arriving at (7) your solution clearly show all your workings, as marks will be allocated. 2.3.2 State five qualitative aspects that the company must evaluate before making a (5) decision in Q.3.1 above. Q.3.3 Briefly explain the difference between avoidable costs, differential costs and (6) opportunity costs. Provide one example of each cost. 2.3.4 List two examples of scenarios where relevant costing can be used effectively in (2) decision-making END OF PAPER
| Variable cost to produce one unit is te relevant cost to be considered here, as fixed costs of the company are going to be incurred, irrespective of the part made in the company or bought from outside. They are incurred, independent on the no.of parts produced. |
| so, the variable costs /unit are: |
| R /unit | |
| Materials | 5 |
| Labor | 15 |
| Variable OH | 10 |
| Total variable/incremental cost/unit | 30 |
| Cost from outside supplier | 35 |
| So, the cost to make the component , 30 < the cost to buy , 35 |
| So, it is advisable TO MAKE the component |
| 3.2 Five qualitative factors before taking the decision to make: |
| 1.Capacity of the company, in terms of fixed assets investment , that the company has to consider before going for the" make" decision |
| 2.Certainty about the quality of its home-made component, that will be suitable for the final product |
| 3.Availablity as well as cost ofany special labor , that is needed to produce the part/component. |
| 4.Growth stage , in which the company is in , currently, to undertake any initial capital outlay. |
| 5.The general view /willingness of the company insiders , to undertake some complicated ventures. |
| 3.3..Avoidable costs are those that cab ne fully eliminated, if one course of action is selected, in the place of another. For example, raw material & labor costs can be fully avoided, when a part is bought rather than manufactured. |
| Differential cost is the incremental cost of one alternative to the other .For example, labor cost for project A might be $ 1000 & the same for project B might be $ 1250. Here, the differential cost is 1250-1000=250 |
| Opportunity cost is the cost(ie. Income)of missing some opportunity, when undertaking another alternative course of action. For example, the rental income ,say $ 3000 lost , while utilising the space for some other business, is an opportunity cost for that business, which should be considered as a negative cash (out)flow while taking a decison to analyse the buiness's prospective cash flows. |
| 3.4.. Relevant costs are those that have an impact on the project's cash flows--ie. Those that pertain to & need be considered. |
| 1.As in the above solution to 3.1--the variable costs--that vary with every unit --are relevant costs for making that " make or buy" decision. The concept of relevant costs are very useful in analysing various cost -alternatives . |
| 2. One other example , is continue or dsicontinie a particular line of business--where all the relevant costs are lined up & analysed. |
| Again, all avoidable costs& opportunity costs are relevant ,in analysing alternatives involving cash costs. |
