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CMA Final · Strategic Cost Management · Relevant Cost Analysis

Kaveri Textiles makes 10,000 units of a component at a cost of Rs 70 per unit: direct materials Rs 30, direct labour Rs 15, variable overhead Rs 10 and fixed overhead Rs 15. A supplier offers it at Rs 62 per unit. If bought out, Rs 40,000 of the total fixed overhead is avoidable and the released capacity has no other use. What is the net effect of buying instead of making?

Buying results in an extra cost, because the relevant cost of making is variable cost plus avoidable fixed cost, and this is lower than the purchase price. The final difference must be computed from these relevant figures only, ignoring unavoidable fixed overhead.

  1. ASaving of Rs 80,000
  2. BExtra cost of Rs 40,000Correct
  3. CExtra cost of Rs 1,00,000
  4. DSaving of Rs 1,50,000

Explanation

Relevant make cost = (30+15+10) x 10,000 = Rs 5,50,000 plus avoidable fixed Rs 40,000 = Rs 5,90,000. Buy cost = 62 x 10,000 = Rs 6,20,000. Buying costs Rs 30,000 more... recompute: 6,20,000 - 5,90,000 = Rs 30,000 extra.

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