Question

What in Articulation, Inc. produces music stands. In its current manufacturing environment, Articulation makes all of the bases used in production. A potential outside supplier has been identified who could supply bases of equal quality to Articulation. Why would it be important for the manager of Articulation to know at what purchase price the company would be economically indifferent between making the bases and purchasing the bases from the outside supplier?

Answer 1

This is a case about Make or Buy decision in management accounting. A company can make the parts or material of the product in the company itself, or it can purchase it from an outside supplier. The costs and benefits associated with producing the product and buying from external supplier are to be compared to take a decision. Whether the company purchases it or manufacture, there are some fixed costs associated with the product which are inevitable. So, while comparing the cost, the variable costs such as additional labour, storage costs, raw material costs etc are to be considered.

If the cost is less than the price charged by the supplier, it is better to make the product in the company. If the cost is more than the purchase price it is better to outsource it.

The company may be economically indifferent between making and purchasing from the outside supplier when the cost is equal to the purchase price of the product charged by the supplier.

The purchase price at which the company would be economically indifferent between making the bases and purchasing the bases from the outside supplier; is the amount of cost for making the product in Articulation Inc. Ii is important for the manager of Articulation to know the purchase price at which the company would be economically indifferent between making and buying, because only then the manager can take make or buy decision.