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Marginal Costing 4

This document discusses make or buy decisions using marginal cost analysis. It provides three examples of companies deciding whether to make a component internally or purchase it externally. In the first example, a TV manufacturer should make component X internally since the marginal cost of Rs. 5 is less than the purchase price of Rs. 5.75. If the purchase price drops to Rs. 4.85, they should buy it. The second example analyzes a machine shop that can make component Y at a marginal cost of Rs. 40 in 2 hours, or purchase it for Rs. 75. It recommends making Y if there is spare capacity. The third example initially recommends making component X5 since the marginal cost of Rs

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227 views3 pages

Marginal Costing 4

This document discusses make or buy decisions using marginal cost analysis. It provides three examples of companies deciding whether to make a component internally or purchase it externally. In the first example, a TV manufacturer should make component X internally since the marginal cost of Rs. 5 is less than the purchase price of Rs. 5.75. If the purchase price drops to Rs. 4.85, they should buy it. The second example analyzes a machine shop that can make component Y at a marginal cost of Rs. 40 in 2 hours, or purchase it for Rs. 75. It recommends making Y if there is spare capacity. The third example initially recommends making component X5 since the marginal cost of Rs

Uploaded by

prapulla suresh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Lecture 4 –Marginal costing -Make or Buy Decisions

Reference :Ravi M Kishore –cost Accounting

When the management is confronted with the problem whether it would be economical to purchase a
component or a product from outside sources, or to manufacture it internally, marginal cost analysis
renders useful assistance in the matter. Under such circumstances, a misleading decision would be
taken on the basis of the total cost analysis. In case the proposal is to buy from outside then, what
is already being made, and the price quoted by the outsider should be lower than the marginal
cost. If the proposal is to make something what is being purchased outside, the cost of making
should include all additional costs like depreciation on new plant, interest on capital involved
and that cost should be compared with the purchase price.

1.A T.V. manufacturing company finds that while it costs to make component X, the same is
available in the market at 5.75 each, with all assurance of continued supply. The breakdown of cost
is:
Materials 2.75 each
Labour 1.75 each
Variable overheads 0.50 each
Depreciation and other fixed cost 1.25 each
6.25 each
(a) Should the company make or buy the component?
(b) What should be your decision if the supplier offered component at `4.85 each?

Marginal cost per unit of component X


Materials 2.75
Labour 1.75
Variable overheads 0.50
Total 5.00

(a) The purchase cost of the above component is 5.75 each. If the company is having spare
capacity which cannot be filled with more remunerative jobs, it is recommended that the
above component be manufactured in the company since the marginal cost at 5.00 each is less
than the purchase cost of 5.75.
(b) In the event of purchase cost of `4.85 each being less than the marginal cost of 5.00 each, it
is recommended that the component be bought from the supplier as this results in a saving of
0.15 each. The spare capacity thus available can be utilized for other purposes, as far as
possible
2. In a machine shop, it takes 4 labour hours to machine and complete a component X. It sells @ Rs.
200 per unit, while marginal cost of sales amounts to Rs. 80 per unit. Another component Y outside.
It can be made in 2 labour hours at a marginal cost of Rs. 40.The price quoted by outside supplier for
the same component is Rs. 75 each. What would you advise?
Comparative cost statement of components

Particulars Component X Component Y

Labour hours required 4 To Make To Buy


2
Rs. Rs. Rs.

Selling Price 200

Less : Marginal cost 80 40

Contribution 120

Contrn. per direct lab. hr. (120/4) 30

Loss of contrn. if Y is made

i.e. opportunity cost of lab. hours 60 (120/2)

Total cost of Y 100

Purchase price of Y 75

If there is spare capacity in the machine shop and demand for X has been fully met, the
Component Y can be made. Otherwise, purchasing is profitable.
3.
Ashok Ltd. finds that while the cost of making a component No. X5 in its own workshop is
Rs. 8 each, the same is available in the market at Rs. 6.50. Give your suggestions whether to
make or buy this component. Give also your views in case the supplier reduces the price from
6.50 to 5.50. The cost data are:
Materials 3.00
Direct Labour 2.00
Other variable exp. 1.00
Depreciation and other fixed 2.00
exp. -------
8.00
To take a decision, the variable cost can be compared with the purchase price; (Fixed cost is not
considered as it will be incurred in any case)

Materials 3.00
Direct Labour 2.00
Other variable exp. 1.00
-------
6.00
====

Decision:-
1.The marginal cost per unit when produced in the factory: Rs. 6,00, purchase price from the
market Rs. 6.50. As the marginal cost is less than the purchase price, it should be produced in the
factory.
2. If the supplier reduces the price from 6.50 to Rs. 5.50: It is better to buy the component as
there is a saving of 50 paise per unit.

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