Question

Make-or-Buy, Traditional and ABC Analysis

Brees, Inc., a manufacturer of golf carts, has just received an offer from a supplier to provide 2,500 units of a component used in its main product. The component is a track assembly that is currently produced internally. The supplier has offered to sell the track assembly for $65 per unit. Brees is currently using a traditional, unit-based costing system that assigns overhead to jobs on the basis of direct labor hours. The estimated traditional full cost of producing the track assembly is as follows:

Direct materials	$40.00
Direct labor	16.00
Variable overhead	4.00
Fixed overhead	40.00

Prior to making a decision, the company’s CEO commissioned a special study to see whether there would be any decrease in the fixed overhead costs. The results of the study revealed the following:

3 setups—$1,180 each (The setups would be avoided, and total spending could be reduced by $1,180 per setup.)

One half-time inspector is needed. The company already uses part-time inspectors hired through a temporary employment agency. The yearly cost of the part-time inspectors for the track assembly operation is $11,790 and could be totally avoided if the part were purchased.

Engineering work: 450 hours, $45/hour. (Although the work decreases by 450 hours, the engineer assigned to the track assembly line also spends time on other products, and there would be no reduction in his salary.)

75 fewer material moves at $30 per move.

Required:

2. Now, using the special study data, repeat the analysis.

It is $ less  expensive to buy outside.

Answer 1

2.

The relevant costs of making the component are Direct material+Direct Labour+Variable overhead and the relevant cost of buying the part is the purchase price .

- Buy Option -

Total Cost to company = 2500 units @ $65 per units = $ 162,500

- Make option- Total cost = Direct Material+Direct Labor+Variable Overhead + costs specially required to manufacture the product in house

As per analysis following are the costs specially required to manufacturethe the product in house ,

Set up cost = 3 setups—$1,180 each = $3540
Part time inspector cost = One half-time inspector Salary = $11,790,
Material Moving cost = 75 fewer material moves at $30 per move = $2,250

* Engineering work decreases but no reduction in his salary

Therefore,
Total cost = Direct Material+Direct Labor+Variable Overhead + costs specially required to manufacture the product
        = Direct material +Direct Labour+Variable overhead+ Set up cost+Part time inspector cost +Material Moving cost
     = (2500 * 40) + (2500 * 16)+ (2500 * 4) + $3540 + $11,790 + $2,250
    = 100,000 + 40,000 + 10000 + $3540 + $11,790 + $2,250
   = $ 167580

By adding these avoidable costs the make option is costiler by (167580 - $ 162,500) = $ 5,080. So the company should go for BUY option instead of manufacturing inside. hence It is $ less  expensive to buy outside .