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CMA Final · Strategic Cost Management · Decisions involving Alternative Choices

Sundaram Auto Parts makes 10,000 units of a component at a variable cost of Rs 140 per unit and fixed cost of Rs 60 per unit (of which Rs 25 per unit is avoidable if production stops). A supplier offers the same component at Rs 180 per unit. If the freed capacity has no alternative use, what is the net annual effect of buying instead of making?

Buying costs Rs 1,50,000 more per year. The relevant cost of making is variable cost Rs 140 plus avoidable fixed cost Rs 25, which is Rs 165 per unit, against the purchase price of Rs 180. The Rs 15 difference on 10,000 units gives the extra cost.

  1. ASaving of Rs 1,50,000 by buying
  2. BExtra cost of Rs 1,50,000 by buyingCorrect
  3. CExtra cost of Rs 2,50,000 by buying
  4. DExtra cost of Rs 4,00,000 by buying

Explanation

Relevant cost of making = variable 140 + avoidable fixed 25 = Rs 165 per unit. Buying costs Rs 180. Extra cost of buying = 15 x 10,000 = Rs 1,50,000. Option with Rs 2,50,000 wrongly ignores the avoidable fixed cost, using only variable cost of 140 (40 x 10,000 = 4,00,000 is the other trap using 140; 2,50,000 uses a different base).

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