March 29, 2015 at 9:31 pm #192984
I am studying for BEC and so confused by the answer of this question;
A company is considering outsourcing one of the component parts for its product. The company currently makes 10,000 parts per month. Current costs are as follows:ﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠ ﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠ
Per unit ﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠﾠ ﾠTotal
Direct materials $4 $40,000
Direct labor $3 $30,000
Fixed plant facility cost $2 $20,000
The company decides to purchase the part for $8 per unit from another supplier and rents its idle capacity for $5,000/month. How will the company's monthly costs change?
The correct answer is Increase $5,000
I don't understand why it increases. It looks like decreases $5,000 to me because the cost of buying will be $85k VS the cost of making will be $90k. So the company will save money $5,000 per by outsourcing. I need help!March 30, 2015 at 12:50 am #660542Sleep OptionalParticipant
I think you have to account for the fixed plant facility cost.
40k+20k+30k = 90k cost to make them yourself.
80k to buy – 5k you get from rent + 20k (fixed plant facility cost). = 95k in monthly costs if you were to buy instead.
Even if you do not make the parts yourself you will still incur 20k every month in costs because it is fixed cost. However 5k of that is offset because you can rent out your idle capacity.
95k – 90k = 5k increase in monthly costs.March 30, 2015 at 11:56 pm #660543
Thanks @Sleep Optional!March 31, 2015 at 4:29 pm #660544AnonymousInactive
The fixed costs are irrelevant, since you have to pay those regardless of whether you make or buy the component. You don't need to include those in your calculations (you can, but it's pointless). For make or buy decisions, when there is excess capacity, the decision is based on whether or not the variable costs of making the item exceed the price you would pay to buy the item.
In this question, your variable costs, if you make the component yourself, are $7 per unit. You can buy the component for $8 per unit. At 10,000 units, buying the component costs you $10,000 more than making the component. However, you will receive $5000 for renting out your idle capacity, so your net costs would be $5,000 more than if you made the component yourself. Thus, if you purchase the component, your profits decrease by $5,000 vs. making it yourself.April 2, 2015 at 4:27 pm #660545
Thanks @Casey TX. that's helpful! Wish you best luck for BEC!!
Cost accounting was my favorite course in college, just don't really remember anymore 🙁January 10, 2017 at 4:18 pm #1434794tweyerParticipant
I know this is an old post, but I came across the question while studying.
The question asks for the effect on MONTHLY COSTS. Costs increase $10,000. Even though now we have an additional $5,000 income, MONTHLY COSTS increased $10,000. Why should we net these? I understand the income is relevant for the decision to make or buy, but that is not what the question is asking.July 6, 2017 at 12:36 am #1582655mpcenter12Participant
@tweyer I completely agree with you. The company's monthly costs increase by $10,000. That is what the question asked. The fact that they are making $5,000 of rental revenue is completely irrelevant to their monthly costs. IMO the question needs to be worded differently, or the answer needs to be corrected.July 7, 2017 at 6:44 am #1583093RadezParticipant
The general impression I had going through the BEC material was that the focus wasn't really on P&L geography so much as it was on business decision-making. Rental income isn't part of opex, but relevant when comparing two different investment strategies. Costs in this context, is more along the lines of net cash outflow, rather than expense in a financial reporting paradigm.May 17, 2020 at 3:01 pm #3004191Gias AhmedParticipant
The total cost to buy the component part = 10,000 x $8 = $80,000,
Rental income = $5,000
Cost to buy the component part = $80,000 – $5000 = $75,000.
Compare this with the cost of making 10,000 units component =10,000 x $7 = $70,000.
Additional cost to buy the component = $75,000-$70,000 = $5,000.
Hence the cost will increase by $5,000.
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