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ACCA Applied Skills · Performance Management · Relevant cost analysis

Ridge Co makes component Z internally at a variable cost of $14 per unit and allocates fixed overheads of $6 per unit, of which only 40% would be avoided if production stopped. An external supplier offers Z at $17 per unit. Ignoring other factors, what is the relevant cost per unit of making Z, and should Ridge buy?

The relevant cost of making is $16.40, being $14 variable cost plus $2.40 of avoidable fixed overhead. This is lower than the $17 purchase price, so Ridge should continue to make Z. Unavoidable fixed costs are irrelevant to the decision.

  1. A$16.40; make, because the relevant cost is below $17Correct
  2. B$14.00; make, because it is below $17
  3. C$20.00; buy, because the relevant cost exceeds $17
  4. D$16.40; buy, because the relevant cost exceeds $14

Explanation

Relevant cost of making = variable cost $14 + avoidable fixed overhead (40% x $6 = $2.40) = $16.40. This is below the buy price of $17, so Ridge should make. Using the full $20 absorbed cost wrongly includes unavoidable overhead.

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