Question

What are the relevant costs to be identified and used in a make-or-buy decision and provide an example of each type of cost.

Answer 1

In make or buy decision, variable costs are considered while making the product. IF the total cost of making the product is lesse than one can go ahead with maing the product else one can buy it.

Costs such as diret materials, direct labour, all the variable overheads and all other variable costs. Also, any expense done exclusively to make the product is also to be considered. For eg. if the firm is buying a special machine for packing the product then that cost has to be considered as well irrespective that it is a fixed cost.

Fixed cost are not considered as they are already incurred and our decision of buying or making the product will not affect fixed costs. Hence they are irrelevant costs.

Example :

Direct Material : $ 10/ unit,Direct Labour : $ 15/ unit,Special machine bought for packing : $100,000,Total units to be produced/bought : 10,000. Cost to buy one unit : $ 37.

Cost of mking the product = $10+$15+$10(100,000/10,000)

= $35

As the cost of making the product is lesser, we will go ahead and amke the product.

However if the product is available in market for $30 then we will buy the product and not make it.