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Performance Management · Make-or-buy and other short-term decisions

Make or Buy Decisions in ACCA Performance Management

Updated 11 October 2026 · Fact-checked

A make-or-buy decision compares the relevant cost of producing an item in-house with the price of buying it in. You include only future, avoidable, cash costs. Make if the relevant cost of making is lower. If a resource is scarce, compare the extra cost of buying per unit of that resource.

Understand Make-or-Buy Decisions

A make-or-buy decision asks whether you should produce a product or component yourself or buy it from an outside supplier. The same logic applies to outsourcing a service.

The key idea is relevant costing. A relevant cost is a future cash flow that changes because of the decision. Ignore sunk costs, committed costs, and absorbed fixed overheads that will be incurred whatever you choose. Only fixed costs that would actually be saved if you stop making the item are relevant.

So the comparison is usually: the variable cost of making (plus any avoidable fixed costs) against the purchase price. If buying is cheaper, the saving is the relevant cost difference. Do not use the full absorption cost. It often includes fixed overheads that do not go away, and this makes making look dearer than it really is.

When capacity is limited, things change. If making the item uses a scarce resource, such as machine hours, buying frees that resource for other products. Then you must find which items are cheapest to buy per unit of scarce resource used. Those are the ones you buy first. This is the limiting factor version of the decision.

Numbers are not the whole story. You must also consider non-financial factors: quality, reliability of supply, control, confidentiality, supplier dependence, effect on staff and morale, and the chance that the supplier raises prices later.

Key rules to remember

Basic make-or-buy rule
Make if relevant cost of making < purchase price; buy if purchase price < relevant cost of making
Relevant cost of making = variable costs + avoidable fixed costs + any opportunity costs. Compare per unit or in total.
Relevant cost of making
Direct materials + direct labour + variable overhead + avoidable fixed costs
Exclude unavoidable fixed overheads and sunk costs. Add opportunity cost if resources have another use.
Limiting factor ranking
Extra cost of buying per unit of scarce resource = (buy price − variable cost of making) ÷ scarce resource units per unit
Buy the component with the lowest figure first. Make the ones with the highest.
Saving or extra cost
Total saving = (relevant cost of making − buy price) × units
A positive answer means buying saves money, before non-financial factors.

How to solve Make-or-Buy Decisions questions

Use this method for any make-or-buy question, with or without a scarce resource.

  1. 1Read the scenario and note if capacity is limited. Check if any fixed costs would be saved or any asset sold.
  2. 2List the costs of making. Keep only future, avoidable cash costs. Cross out absorbed fixed overheads that continue.
  3. 3Add opportunity costs, such as lost contribution or rent from using freed space, if the question gives them.
  4. 4Compare with the purchase price per unit, or in total for the volume needed.
  5. 5If a resource is limited, calculate the extra cost of buying per unit of that resource for each item. Rank them lowest first.
  6. 6Allocate the limited resource to the items to make, starting from the highest extra cost of buying, until it runs out. Buy the rest.
  7. 7Calculate the total cost or the saving from your plan.
  8. 8State the recommendation and add non-financial factors such as quality, supply risk and control.

Quickest way: Variable cost versus buy price, then rank per scarce hour

When to use it: Use it when the question gives unit costs with fixed overhead absorbed and you are short of time.

  1. Strike out absorbed fixed overhead unless the question says it is avoidable.
  2. Subtract the variable cost of making from the buy price for each item. This is the extra cost of buying.
  3. If a resource is limited, divide that extra cost by the scarce units per item and rank.
  4. Make the highest-ranked items until the resource runs out, then buy the rest.
  5. Write one line on non-financial factors for the written marks.

Common mistakes in Make-or-Buy Decisions

  • Using the full absorption cost of making.

    The question lists a total unit cost and it looks like the obvious figure.

    Fix: Remove fixed overheads that continue whether you make or buy. Use only variable and avoidable fixed costs.

  • Choosing the item with the largest total extra cost of buying to make, when capacity is limited.

    Students forget that scarce resource use differs by item.

    Fix: Divide the extra cost of buying by the scarce resource per unit. Rank on that figure.

  • Ignoring opportunity cost.

    Students focus on the cost lines in the table only.

    Fix: If making uses space, labour or machines with a better alternative use, include the lost benefit as a cost of making.

  • Forgetting avoidable fixed costs.

    Students assume all fixed costs are irrelevant.

    Fix: Fixed costs such as a supervisor's salary that would be saved if production stops are relevant.

  • Giving a numbers-only recommendation.

    Students run out of time or treat it as a pure calculation.

    Fix: Add at least two non-financial points, such as supplier reliability, quality control or loss of skills, and say how they affect the choice.

Worked examples

Example 1

Rana Ltd makes a component. Each unit costs: materials ₹40, labour ₹30, variable overhead ₹10, absorbed fixed overhead ₹20, total ₹100. A supplier offers it at ₹85. Rana needs 5,000 units. Fixed overheads are unchanged whether it makes or buys. Should Rana buy?

Show the solution
  1. Relevant cost of making per unit = 40 + 30 + 10 = ₹80. The ₹20 fixed overhead continues, so ignore it.
  2. Buy price = ₹85 per unit.
  3. Extra cost of buying = 85 − 80 = ₹5 per unit.
  4. Total extra cost = 5 × 5,000 = ₹25,000.
  5. Making is cheaper on relevant costs.

Answer: Do not buy. Making saves ₹25,000 compared with buying. Consider quality and supply risk only if they strongly favour the supplier.

Example 2

Sen Co needs three components. Machine time is limited to 2,000 hours. Data per unit: A needs 2 hours, variable cost of making ₹50, buy price ₹62. B needs 3 hours, variable cost ₹70, buy price ₹94. C needs 1 hour, variable cost ₹30, buy price ₹37. Demand is 500 units of each. Decide what to make and buy, and find the total cost.

Show the solution
  1. Hours needed to make all: A 500 × 2 = 1,000; B 500 × 3 = 1,500; C 500 × 1 = 500. Total 3,000 hours. Only 2,000 are available, so machine time is a limiting factor and some units must be bought.
  2. Extra cost of buying per unit: A 62 − 50 = ₹12; B 94 − 70 = ₹24; C 37 − 30 = ₹7.
  3. Extra cost of buying per machine hour: A 12 ÷ 2 = ₹6; B 24 ÷ 3 = ₹8; C 7 ÷ 1 = ₹7.
  4. Rank for making, highest first: B (₹8), then C (₹7), then A (₹6).
  5. Allocate hours: make 500 units of B using 1,500 hours. Make 500 units of C using 500 hours. Total 2,000 hours, so the hours are used up. Buy all 500 units of A.
  6. Total cost = make B 500 × 70 = ₹35,000; make C 500 × 30 = ₹15,000; buy A 500 × 62 = ₹31,000. Total = ₹81,000.
  7. Check: making all would cost 500 × 150 = ₹75,000, but needs 3,000 hours. Buying A frees 1,000 hours at an extra cost of 500 × 12 = ₹6,000. 75,000 + 6,000 = ₹81,000.

Answer: Make 500 units of B and 500 units of C, and buy 500 units of A. The total relevant cost is ₹81,000. A is bought because it has the lowest extra cost of buying per machine hour (₹6).

Exam tips

  • Read the scenario for which fixed costs are avoidable. Examiners often hide this in one sentence.
  • Show the relevant cost of making as a clear list so you earn method marks even if a figure is wrong.
  • In limiting factor questions, show the extra cost of buying per scarce unit for every item. The ranking earns marks.
  • In Section C, finish with a short written recommendation that lists non-financial factors for and against outsourcing.
  • In objective tests, check whether the question asks for the saving, the total cost, or the maximum price you would pay.

Practice questions from Make-or-buy and other short-term decisions

Make-or-Buy Decisions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Make-or-Buy Decisions: frequently asked questions

What is the difference between a make-or-buy and a shut-down decision?

A make-or-buy decision compares making an item with buying it in, and the activity continues. A shut-down decision asks whether to close a product, department or site, comparing contribution lost with the fixed costs saved. Both use relevant costing, but the choices are different.

How do you do a make-or-buy decision with a limiting factor?

Work out the extra cost of buying each item compared with making it. Divide by the scarce resource used per unit. Make the items with the highest figure first, and buy the rest once the resource is used up.

What non-financial factors affect make or buy?

Key factors include quality, reliability and speed of supply, control over the process, confidentiality, dependence on one supplier, effect on employees and the supplier's long-term pricing. These can override a small cost saving.

Should absorbed fixed overheads be included?

Only if they would be saved by buying. If the overhead continues either way, it is not relevant and should be excluded from the cost of making.