APPLICATIONS OF MARGINAL COSTING - Accounts and Finance for Managers

Make or Buy Decision

The firms which are routinely in need of spares, accessories are bought from the outsiders instead of any production or manufacturing, though the requirement is at regular intervals. Most of the automobile manufacturers are usually buying the components from outside instead of producing them on their own. The Maruthi Udyog ltd had given a contract to the Nettur Technical Training Foundation, Bangalore to design the tool for the panel and to manufacture regularly to the tune of the orders.

The leading four wheeler manufacture in India is buying the panel from the NTTF on contract basis instead of manufacturing.

Why don't they manufacture in spite of buying them from the NTTF ?

The main reason of buying is cheaper than the production of an article.

Illustration

The management of a company finds that while the cost of making a component part is Rs. 20, the same is available in the market at Rs.18 with an assurance of continuous supply.
Give a suggestion whether to make or buy this part. Give also your views in case the supplier reduces the price from Rs.18 to Rs.16.

The cost information is as follows
Material Rs 7,00
Direct Labour Rs.8.00
Other variable expenses Rs.2.00
Fixed expenses Rs. 3.00
Total Rs.20.00

The first point to be found out that the contribution of the transaction. The cost of manufacturing should be compared with the price of the product which is available in the market.

To find out the worth of the transactions, first the cost of manufacturing should be found out
Material Rs. 7.00
Direct Labour Rs. 8.00
Other variable expenses Rs. 2.00
Total Rs.17.00

The cost of manufacturing a component is Rs.17.00. While calculating the cost of manufacturing a component, the fixed expenses was not considered. The fixed expenses were not considered for computation. Why?

The costs will be incurred irrespective of the production status of the firm; for which the expenses should not be added.

If the company manufactures the product / component at Rs.17 which will facilitate to book profit Rs. 1 from the price of Rs.18 which is available from the market. The next stage is decision criteria.

Worth of Production

Cost of the production < Price of the product available in the market.The firm is better advised to take the course of production rather than purchase of the product.

Worth of Purchase

Cost of the production > Price of the product available in the market

The product available in the market is dame cheaper than the manufacturing of a product. The firm is better advised to buy the product rather than the manufacturing of a product. If the product price comes down to the price of Rs.16 facilitates the firm to save Re 1 from the cost of manufacturing.

Illustration

A refrigerator manufacturer purchases a certain component @ Rs.50 per unit. If he manufactures the same product he has to incur a fixed cost of Rs.20,000 and variable cost per unit is Rs. 40/- when can the manufacturer make on his own or when he can buy from outside ?

When the requirements is Rs.5,000 units, will you advise to make or buy?

The very first point to be found that Break even point in units.
The break even point in units at which the cost of buying is equivalent to the cost of manufacturing.

The cost of purchase per unit - Rs 50/-

If the same product is manufactured, what would be the total cost of manufacture ?
Total cost of manufacture= Total fixed cost + Variable cost

The cost of buying is felt that an exorbitant one than the cost of manufacturing. Having observed, as a manufacturer undergoes for the manufacturer of a component. If he manufactures a component, he could save Rs.10=( Rs.50–Rs.40) Which in other words known as contribution per unit
Before finding out the Break even point in units, the contribution of the product should be found out.
Contribution margin per unit= Selling price in the market – Cost of manufacture
Contribution margin per unit is nothing but the amount of savings to the manufacture.
Amount of savings out of the manufacture = Purchase price – Variable cost
Though the firm enjoys savings, it is required to additionally incur fixed cost of operations Rs.20,000

Break even point in units=
Fixed cost
Purchase price- Variable cost
=
Rs.20,000
Rs.50–Rs.40
=2,000 units




At 2,000 units, the firm considers both alternatives are incurring equivalent volume of Cost in manufacturing.
Cost of buying for 2,000 units
=2,000 units * Rs.50 per unit= Rs. 1,00,000
Cost of Buying Break even in Rupees
= Rs.20,000 + 2,000 units * Rs.40 = Rs.1,00,000
From the above, it obviously understood that both are bearing equivalent amount of costs. It means both are neither profitable nor non- profitable.

illustration

The next step is to identify the worth of either manufacturing the units or buying the units at 5,000
If the manufacturer buys from the outsider= 5,000 * Rs.50= Rs.2,50,000
If the same manufacturer produces the component instead of buying
=Rs.20,000+ Rs.2,00,000= Rs.2,20,000
From the above, the company is finally advised to manufacture the component due to low cost of manufacture.


All rights reserved © 2018 Wisdom IT Services India Pvt. Ltd DMCA.com Protection Status

Accounts and Finance for Managers Topics