Question

The management of Bar.Co have asked for your assistance in deciding whether to continue manufacturing a component or buy it from an outside supplier. The component in question is the Sicio that is used as a component on many of the finished products produced by Bar.Co. You have been provided with the following information: 

Bar.Co’s normal annual requirement is for 5,000 Sicios per year. 

Bar.Co’s purchasing department has asked external suppliers to quote for the supply of Sicios. The lowest quotation they have received is for a price of £10 per Sicio for a supply of between 4,000 and 6,000 Sicios per year. 

Sicios are currently manufactured by Bar.Co’s precision engineering department, using specialised machinery. If Sicios are purchased from outside this machinery, which is in the last year of its useful life and not in a condition to be sold, will be scraped at a cost of £200. The net book value of this machinery is £1,000. 

The costs of the precision engineering department, including those associated with the manufacturing of Sicios are estimated to be:

   £

Direct materials    67,500

Direct labour 50,000

Indirect labour 26,500

Light and heat 5,500

Power    3,000

Depreciation (specialised machinery) 1,000

Depreciation (other machinery) 9,000

Other fixed departmental overheads 5,000

The cost accountant of Bar.Co has estimated that the cost of manufacturing Sicios by the precision engineering department is £16.50 per Sicio made up as follows:

   £

Direct materials    3.50

Direct labour 5.60

Departmental overheads    4.60

Company overheads 2.80

The departmental overheads and the company overheads are not specific to Sicio and have been allocated to the component based on direct labour cost.


 The impact on the precision engineering department of ceasing to produce Sicios internally, other than the savings in direct costs specifically associated with manufacturing Sicios, is estimated to be:

Savings of £6,500 in indirect labour; savings of £1,000 in light and heat costs. No savings are expected for power costs and depreciation of other machinery;

An increase in other departmental fixed overheads of £4,000 because of increased activity in goods reception and inspection.

Based on this information the cost accountant is in favour of discontinuing the in-house manufacturing of Sicios.

Required:

a) Prepare a report that identifies, showing any necessary calculations, the total cost for the precision engineering department when Sicios are produced in-house and when they are purchased from an outside supplier, highlighting any difference in each cost item. You are also required to provide your advice regarding the proposed change in the sourcing of Sicios.

b) Discuss any non-financial issues you think should be taken into account in making this decision. Word limit: 400 words.

c) When a business seeks to understand what costs are relevant for a decision, it may have to identify sunk costs and opportunity costs. Explain what you understand by relevant costs, sunk costs and opportunity costs, providing examples. Word limit: 400 words.

Answer 1

Part a)