Question

Make or Buy Assignment

RJ Electronics manufacturing a variety of computer appliances. An outside supplier offered to sell a Headset called Genius to RJ Electronics for $28 per unit

To evaluate this offer, RJ has gathered the following information relating to its own cost of producing the Headsets internally:

Details	16,000 unit per year
Direct materials	160,000
Direct labor	128,000
Variable manufacturing overhead	96,000
Fixed manufacturing overhead – traceable	80,000
Fixed manufacturing overhead – common but allocated to headset line	224,000
Total Cost	688,000

Required:

Assuming that traceable overhead includes 30% headset line maintenance and 70% advertising for headsets only, should the outside supplier’s offer be accepted?

Analysis should be done based on both total and differential approaches.

Answer 1

	TOTAL APPROACH
	Particulars	Make	Buy
	Cost of Purchasing		$448,000	(28*16000)
	Direct material cost	$160,000
	Direct labor	$128,000
	Variable manufacturing overhead	$96,000
	Fixed Manufacturing overhead - Traceable #	$24,000		(80,000*30%)
	Total Cost	$408,000	$448,000
	# Out of total $80,000 traceable fixed cost, 70% is related to advertising which will continue to incur even if
	headsets are purchased instead of manufacturing. Hence it is irrelevant cost.
	Since, Cost of the buying the headsets are $40,000 more than making it. RJ electronics should
	MAKE IT instead of buying it.
	DIFFERENCIAL APPROACH
	Cost of Buying	$448,000
	Less: Direct material cost avoided	-$160,000
	Less: Direct labor cost avoided	-$128,000
	Less: variable manufacturing cost avoided	-$96,000
	Less: Traceable fixed cost avoided	-$24,000
	Net differencial cost of Buying	$40,000
	Since, Cost of the buying the headsets are $40,000 more than making it. RJ electronics should
	MAKE IT instead of buying it.