Question

Lavender is considering whether to make or buy some of the components used in the production of deodorants. The annual cost of producing these components used by the company is as follows: Component A Component B Direct variable manufacturing costs $300,000 $200,000 Direct fixed manufacturing costs $100,000 $50,000 Allocated overhead $50,000 $50,000 Quantity produced 100,000 200,000 The fixed manufacturing costs allocated to component A would be reduced by 80% if the company were to discontinue production of component A. As part of the company cost planning and cost control of operations and activities, management is now reviewing the unit product cost of the components used in the production of its deodorants. Required a) What are the unit product costs of component A and B considering both are produced by the company? b) Which and how much are the relevant and irrelevant costs in the decision of discontinuing production of component A? c) Considering only component B is produced by the company, what is the unit product cost of component B?

Answer 1

A.unit product costs of component A and B considering both are produced by the company

Component	A	B
Direct variable Manufacturing costs	300,000	200,000
Direct fixed Manufacturing costs	100,000	50,000
Allocated Overhead	50,000	50,000
Total Cost	450,000	300,000
Quantity produced	100,000	200,000
cost per Quantity	4.50	1.50

C. Considering only component B is produced by the company, unit product cost of component B

Component	B
Direct variable Manufacturing costs	200,000
Direct fixed Manufacturing costs	50,000
Allocated Overhead	50,000
Total Cost	300,000
Allocated Overhead to be continued after discontinuing the product A(50000*20%)	10,000
Total Cost	310,000
Quantity produced	200,000
cost per Quantity	1.55

B.  Relevant and irrelevant costs in the decision of discontinuing production of component A

Clasification of costs into releveant and irrelevant cost is important for decision making by management .irrelevant costs are the costs which are fixed in nature in any decision taken by the management.

Few irrelevant costs are

1.Fixed overhead costs,

2.Already incurred costs,

3.Future committed costs.

Relevant costs are the costs which will change between the options considered by the management .these costs vary among the options choosen by the management.

Few Relevant cost are

1.Variable Costs,

2.Variable overheads etc

In the given case 20% of allocated overhead is irrelevant cost because these amount incurred by the management in both the options either continued the production of component A or buying the same.

Please note that relevant and irrelevant costs may differe for each management and their nature of business .

Thanks and Regards.