Question

The management of The Wall Corporation requests assistance from its cconomic analyst in arriving at a decision whether to continue manufacturing a certain part of an assembly or to buy it from an outside supplier who has been quoting a price of $8.00 per unit. The company's annual requirement is 5,000 units and the costs accumulated for their manufacture are: Direct Materials Direct Labour Indirect Labour $20,000 10,000 6,000 Power 400 Other costs 600 If the parts are purchased outside, present machinery used to make the parts could be sold and its book value would be realised. This step would reduce total machinery depreciation by $2,000 and insurance by $1,000. If the parts were purchased from an outside supplier, the following additional costs would be incurred: Freight $0.50 per unit Indirect labour $5,000 Required: (a) A statement comparing the costs of manufacturing the parts with the costs of purchasing them from the outside supplier. (b)A brief discussion dealing with matters other than cost factors of which management should be made aware.

Answer 1

a.

Costs	Make	Buy	Net Income Increase / (Decrease)
Direct Materials	20,000		-20,000
Direct Labor	10,000		-10,000
Indirect Labour	6,000	5000	-1,000
Power	400		-400
Other costs	600		-600
Freight		2500	2500
Purchase price		40000	40,000
Reduction in costs		-3000	-3,000
Total	37,000	44,500	7,500

b. Others factors to consider while deciding a make or buy decision:

1. The quality of the goods supplied by the supplier must be considered else a defective component can cause harm the reputation.

2. If the supplier is reliable and there must be no interruption in delivery of goods to significantly influence firm's production.

3. The price changes when supplies are bought also must be considered.

4. If the firm decides to manufacture, the labor and materials costs and the cost of maintaining the personnel must be considered.