Relevant Costing for Short-term Decision Making

Make or Buy Decision

SCENARIO 1

Currently, Senah Auto is producing 10,000 units per annum of component called ‘Senget’. The assigned costs are as follows;

	Total cost  of @10,000 units of ‘Senget’ RM	Unit Cost RM
Direct material AB	120000	12
Direct labour	100000	10
Variable manufacturing overhead cost	10000	1
Fixed manufacturing overhead cost	80000	8
Share of non-manufacturing overheads	50000	5
Total cost	360,000	36

The above costs are expected to remain unchanged in the future if Senah Auto continues to manufacture the components.

Joyah Sport, a supplier has offered to supply 10,000 components per annum at a price of RM30 per unit and they guaranteed that they can supply the components for the next three years.

If, Senah Auto outsources this component, the direct labour currently employed to manufacture this component will be made redundant, and no redundancy cost will be incurred. Direct materials and variable overhead are avoidable if ‘Senget’ component is outsourced. Fixed manufacturing overhead cost would be reduced by RM10,000 per annum but non-manufacturing costs would remain unchanged.

Should Senah Auto make or buy the ‘Senget’ component?

SCENARIO 2

Assume now the extra capacity that will be made available from outsourcing component ‘Senget’ can be used to manufacture and sell 10,000 units of new component called ‘Sengau’ at a price of RM34 per unit. All labour force (may the force be with you) required to manufacture component ‘Senget’ would be used to make component ‘Sengau’. The variable manufacturing overheads, the fixed manufacturing overheads and non-manufacturing overheads would be the same as the costs incurred for manufacturing components ‘Senget’. Materials AB required to manufacture component ‘Senget’ would not be required but additional materials XY required for making component ‘Sengau’ would cost RM13 per unit.

Should Senah Auto outsource component ‘Senget’?

- adapted from Colin Drury