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

Zenith Ltd is deciding whether to make a component in-house or buy it in for 1,000 units. Making costs: direct materials $6, direct labour $4 (labour is fully available and paid as a fixed salary), variable overhead $3, and absorbed fixed overhead $5 per unit, of which only $2 per unit would be avoided if production stopped. The external supplier quotes $13 per unit. What is the financial advantage or disadvantage of buying rather than making?

Buying costs $2,000 more. The relevant cost of making is $11 per unit: materials $6, variable overhead $3 and avoidable fixed overhead $2. Fixed-salary labour and unavoidable overhead are irrelevant. Buying at $13 is $2 per unit dearer, so $2,000 over 1,000 units.

  1. ABuying saves $2,000
  2. BBuying costs $2,000 moreCorrect
  3. CBuying costs $4,000 more
  4. DBuying saves $1,000

Explanation

Relevant cost of making = materials 6 + variable overhead 3 + avoidable fixed overhead 2 = $11 per unit. Labour is a fixed salary and unavoidable, so it is irrelevant. Buying at $13 costs $2 more per unit, giving $2,000 more for 1,000 units. Including labour would give $15 and wrongly suggest a saving of $2,000.

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