Hello,
Other supplementary solution for the given problem is:
A) Inhouse (only the relevant cost or incremental without fixed cost)
Direct Material = $ 2,000.00
Material Handling - Direct = 400.00 (20%of DM)
Direct Labor = 16,000.00 (150% of DL)
Mfg. Overhear Variable only = 8,000.00 (24k x 1 ÷ 3 or 1/3)
Total relevant Cost per unit = $ 26,400.00
Versus :B) Outsourced / Buy outside = *** $ 36,000.00
*** Direct material + Materials handing* (30kx20%) = $ 30,000 + 6000*
Difference between Make or Buy = (26,400 - 36,000 =
$ 9,600/ unit Increase if we opted to Buy.However buying from outside source would also mean the company will have some idle capacity and that can still produced another product that will provide a monthly
Incremental revenue for $ 104,000.00, therefore the net Opportunity cost of buying from outside source is $8,000.00 (see below)
Incremental Revenue = $ 104,000.00
Total Incremental Cost ($9,600 x 10 units) = $ 96,000.00
Net Opportunity Cost = $ 8,000.00------------------------------
Mark Anthony Pusing
Accountant
Blue Steel Factory W.L.L.
Doha
Qatar
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Original Message:
Sent: 02-08-2014 10:42 AM
From: Angel Secerio
Subject: Part I - Opportunity cost
In any make or buy decision, the alternative having the lower relevant cost should be preferred. Costs are considered relevant when they are differential and incremental in nature. The opportunity cost in the instant case is US$8,000 being the amount Richardson would have saved each month had it elected to buy instead of producing T305.
The relevant costs to manufacture are as follows: (a) variable production costs, (b) materials handling costs of 20% (incidentally this applies to both options). Therefore, the relevant cost under this option is US$ 36,800 per unit, calculated as follows:
$ 2,000 - Direct materials
$ 400 - Handling costs (20% X $ 2,000)
$16,000 - Direct labor
$ 8,000 - Variable Manufacturing costs ($24,000 X 1/3)
$10,400 - Opportunity cost (Contribution margin lost)
$36,800 - Relevant cost to manufacture one T305
The relevant cost if Richardson buys from third party is the total of the (a) purchase price of the part, (b) materials handling costs of 20%.
$30,000 - Purchase price
$ 6,000 - Handling costs (20% X $ 30,000)
$36,000 - Relevant cost to buy one T305
Therefore, if Richardson chooses to manufacture the ten T305, its opportunity cost is $8,000.
$36,800 - Cost to manufacture
$36,000 - Cost to buy
$ 800 - Opportunity cost per unit
X) 10 - Monthly production requirement of T305
$ 8,000 - Opportunity cost of manufacturing T305
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Angel Secerio, CMA, CPA, CGMA, CFE
Director/Manager
Insights Financial Review
Makati
Philippines