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CMA Final · Strategic Cost Management · Decisions involving Alternative Choices

Kaveri Plastics makes 20,000 units of a component at a full cost of Rs 42 per unit, comprising variable cost Rs 30 and fixed overhead Rs 12 absorbed. An outside supplier offers the component at Rs 36 per unit. Of the total fixed overhead, 40% would be avoided if production stops, and the released capacity has no alternative use. What is the effect of buying instead of making?

Buying costs more. Making has a relevant cost of Rs 34.80 per unit (variable Rs 30 plus avoidable fixed Rs 4.80), against Rs 36 to buy. The difference is Rs 1.20 per unit, so on 20,000 units buying raises cost by Rs 24,000.

  1. ASaving of Rs 1,20,000
  2. BIncrease in cost of Rs 1,20,000Correct
  3. CIncrease in cost of Rs 2,16,000
  4. DSaving of Rs 2,16,000

Explanation

Relevant cost of making = variable Rs 30 + avoidable fixed (40% of Rs 12 = Rs 4.80) = Rs 34.80 per unit. Buying costs Rs 36, so the extra cost is Rs 1.20 per unit, or Rs 24,000 in total on 20,000 units. Rechecking with totals: make = 20,000 x 34.80 = Rs 6,96,000; buy = Rs 7,20,000; difference Rs 24,000.

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