Step 5 arrive at a final make or buy decision after

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Step 5 Arrive at a final make-or-buy decision after considering both quantitative and qualitative factors. This would depend on the particular business and what it is doing so as to create profits. Continuing with the above example, even if it is likely that the business may buy better grade products than those it can manufacture in-house, the quality of its goods/products may not have a bearing on its sales on the basis of its business model and what it is putting on the market. If such is the case, the wish to develop a long-term relationship may or may not be adequate to prevail over the $1,000 savings in expenses; instead it depends on how strong is the business’ yearning for the relationship and what it hopes to accomplish by starting it.
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79 6.3.4 EXAMPLE FOR MAKE OR BUY Here is a hypothetical example for coming to a make-or-buy decision. A reputable skateboard company is now manufacturing the heavy duty bearing that is utilized in its most liked line of skateboards. The business’ accounting section reports the following expenses for manufacturing 8000 units of the bearings internally every year. Direct Materials $6 x 8000 = $48,000 Direct Labor $4 x 8000 = $32,000 Supervisor Salary $3 x 8000 = $24,000 Variable Overhead $1 x 8000 = $8,000 Allocated general overhead $5 x 8000 = $40,000 Depreciation of special equipment $2 x 8000 = $16,000 Total Expense $21 x 8000 = $168,000 An external supplier offered to sell 8000 bearings to the skateboard company for only $19 per bearing. Should the business cease manufacturing the bearings internally or instead, purchase them from an external supplier? To arrive at a make-or-buy decision, the focus should, at all times, be on the relevant costs (the ones that differ between the alternatives). The expenses that differ between alternatives comprise the expenses that could be prevented by buying the bearings from an external supplier. If the expenses that can be avoided by buying bearings from the external supplier amount to less than $19, the business must continue to manufacture its bearings a nd reject the external supplier’s offer. On the other hand, if the expenses that can be prevented by buying the bearings from the external supplier amount to more than $19, the external supplier’s offer should be accepted. You can use the setup below to manage your applicable/avoidable expenses. Total applicable/avoidable expense for Making 8000 units: Direct Materials $6 x 8000 = $48,000 Direct Labor $4 x 8000 = $32,000 Supervisor Salary $3 x 8000 = $24,000 Variable Overhead $1 x 8000 = $8,000 Allocated general overhead not Relevant Depreciation of special equipment not Relevant Total Expense $14 x 8000 = $112,000 Total expense for Buying 8000 Units: Outside purchase expense $19 x 8000 = $152,000 The difference of $40,000 supports continuing to make 8000 units. Keep in mind that depreciation of special equipment is mentioned as one of the expenses for manufacturing the bearings internally. Owing to the fact that the equipment has already been bought, this depreciation is a sunken expense and is, therefore, not applicable. If the equipment could be utilized to create another product, this may be a relevant expense as well. Still, we suppose that the equipment has no salvage value and no other use.
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