Relevant cost - Make or Buy

RELEVANT COST – MAKE OR BUY

The MotorGo Corporation makes steering wheel covers for cars. These steering wheel covers have the following cost structure.

Units produced	5,000 units
Variable cost per unit	12.00
Fixed cost per unit	4.00

The Auto Fun Corporation has offered to make the steering wheel covers for RM15.00 each. If the offer is accepted, the variable costs will be eliminated but the fixed costs will remain.

Required:

Should MotorGo accept the offer? How much additional income will be materialize by taking the offer?






RELEVANT COST – MAKE OR BUY

Teha Kasut manufactures a variety of athletic shoes. The company always produced all necessary parts for its shoes, including laces. Lita Tali, an outside supplier has offered to produce and sell laces to Teha Kasut at a cost of RM0.20 per lace.

To evaluate this offer, Teha Kasut has gathered the following information relating to its own cost of producing laced internally:

	Per Unit RM	26,000 laces per year RM
Direct materials	0.06	1,560
Direct labour	0.07	1,820
Variable manufacturing overhead	0.02	520
Fixed manufacturing overhead, traceable	0.03	780
Fixed manufacturing overhead, allocated	0.06	1,560
Total Cost	0.24	6,240

One-third of the traceable fixed manufacturing overhead relates to supervisory salaries. The supervisor would be fired if Teha Kasut chose to purchase from outside supplier. Two-thirds of the traceable fixed manufacturing overhead relates to depreciation of lace-making equipment that has no resale value.

Required:

1. Assuming that the company has no alternative use for the facilities that are now being used to produce the laces, should the outside supplier’s offer be accepted? (Show your workings)
2. Suppose that if the laces were purchased, the company could use the freed capacity to make a new product. The segment margin of the new product is expected to be RM1,000 per year. Should the company accept the offer to buy the laces for RM0.20 per lace? (Show your workings)

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MFRS 102 Inventories

MFRS 102 Inventories

Firstly, this MFRS applies to companies holding inventories in their course of business. These inventories came from transactions which involving the business and the supplier. It can be transacted either by cash, cheque or on credit. Of course, the objective of the business is to generate profit by selling their inventories or services. But, why we need this MFRS 102?

My explanation regarding this is simple. MONEY!!!. We buy them, we sell them, customers happy and we are happier as well. If we buy something and straight away sell them, there will be no inventories as we don't hold anything in our possession. Our warehouse will be empty and we don't even bother to check or calculate how much inventories left in it. When we mentioned about how much and the word calculate, then the inventories can be measured because they can be turned into money. Get that?

So in summary, I took this from the net... which I found relevant and might help you to understand the objective of providing the information regarding inventories.

The existing and potential customers are interested to know whether the inventories are managed efficiently and cost-effectively.

Example:

An entity purchases inventories from suppliers for resale in the future. Some of the inventories are kept for minimum stock level requirement to prevent stock-outs.

Solution:

The existing and potential customers may like to see if there is no excess inventories and a well-managed inventory turnover. A proper management of inventories indicates that the entity has reasonable cash flows from selling and purchasing of inventories. 

Definition

Inventories are assets

(a) held for sale in the ordinary course of business

(b) in the process of production

(c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.

Treatment

Inventories are classified as  current assets in the financial statements when:

(a) It expects to realize the asset, or intends to sell or consume it in its normal operating cycle.

(b) It holds the asset primarily for the purpose of trading.

(c) It expects to realize it within twelve months after the reporting period.

Example:

An entity purchases flour for its biscuit factory.

Solution:

The flour is raw material purchased by the entity and used in the production of biscuit in the factory. The raw material is an inventory classified at current assets in the financial statements because it expects to sell the biscuits in its normal operating cycle within twelve months after the reporting period.

Recognition and Measurement

Inventories shall be recognized and measured at the lower of cost and net realizable value.

Cost of the inventory includes all costs incurred to bring the inventory to its present location and condition. It will include all costs of purchase, conversion costs and all other costs. 

Example:

An entity purchases 500 units of finished goods from supplier costing of RM5,000 for resale to its customers. The net realizable value of the inventories is RM5,200.

Solution:

The finished goods are inventories because they are purchased for the purpose of trading and the inventory, RM5,000 is measured at cost.

The cost of inventories would be recorded as below:

Debit  Inventories/purchase a/c    5,000

      Credit  Bank a/c                             5,000

but it is not as simple as that....

The following costs should be excluded as inventories costs:

•Abnormal amount of wastage including material, labour and overhead

•Storage cost

•Administrative cost

•Selling cost

•SST

Net Realisable Value

MFRS 102 defines net realisable value as ‘the estimated selling price in the ordinary course of business less estimated costs of completion and the estimated costs necessary to make the sale’.

Inventory valuation

•Specific Identification Method

•First In First Out (FIFO) and

•Weighted Average Methods

•Other Methods

–Techniques such as standard cost and retail price may be used for convenience if the results approximate cost

Last In First Out (LIFO) is prohibited

Writing Down to Net Realizable Value

Generally, inventories are written down to net realisable value item by item. Other basis is to group similar or related items.

Raw materials and supplies held in the manufacture or production of finished goods are not generally written down below costs if the finished goods in which they are incorporated are expected to be sold above costs. 

Presentation

Inventories are presented as an item of current assets in the statement of financial position.