Acct618 Managerial Accounting-Buying Decision Answers Assessment Answers

In this paper, please discuss the following case study. In doing so, explain your approach to the problem, support your approach with references, and execute your approach. Provide an answer to the case study’s question with a recommendation.

Case Study:

Assume that a firm has prepared the following cost estimates for the manufacture of a sub assembly component based on an annual production of 8,000 units.

The supplier has offered to provide the subassembly at a price of $16 each. Two-thirds of fixed factory overhead, which represents executive salaries, rent, depreciation, and taxes, continue regardless of the decision. Should the company buy or make the product?

Superior written essays will mention and explain the following elements when responding to the assignment question:

• Provide a solution and recommended decision.
• Provide a narrative about the approach to the problem.
• Provide supporting references.

Be sure to use APA formatting in your paper. Purdue University’s Online Writing LAB (OWL) is a free website that provides excellent information and resources for understanding and using the APA format and style.

Answer:

This case study is an attempt to understand the make and buy decisions for a firm. Make and buy decision is a strategic decision for the firm where they need to choose between producing an item internally or buying it externally from other suppliers (Inman, 2018). We can work on a rule of thumb for out-sourcing wherein a firm should not outsource under the following three conditions: (Burt, Dobler, and Starling, 2003)

• The sub part is a critical path item in the production line
• The item is a specially designed for the firm
• The item is a core competency of the firm.

Many a times these industries require sub parts which they can either choose to produce or buy, this decision of choosing between producing the product at own units or buying it from other concern or outside suppliers is popularly known as the making or buying decision. Making or buying is a decision which requires understanding the relevant cost of the transaction for the concern. Strategizing in the business world ultimately boils down to the undertaking of the make-or-buy-or-cooperate decisions of the firm. (Sousa, 2012)

These decisions for firms are based on two factors namely, Qualitative and Quantitative. (Wilkinson, 2013):

• Qualitative factorsinclude ensuring the quality of the products and at the same time maintaining healthy relationship to keep the supplies continuous.
• The quantitative featuresinvolve analysing the cost of both the alternative and picking up the one which is less costly for the firm.

Thus, we see that the cost analysis should be carried out using the relevant cost approach. The relevant costs are those costs which can be avoided if we choose to buy the product from an outside supplier. Examples of this relevant cost are the cost of material, labour and variable manufacturing overheads.

 Approach to the Problem:

Here, the firm can make the product - sub assembly component in-house or can purchase it directly from an outside supplier. The approach is to assess the relevant cost of both these options and choose the lower cost option:

• Option 1: Continue to make the sub assembly component in house
• Option 2: Buy it from the supplier @ $16 per component

Solution:

Recommendation:

The firm should continue to make the sub-assembly component in-house as that would cost lower, than purchasing it from the outside suppliers.

Explanation:

This firm currently manufactures sub assembly component at a total cost per unit of $19 per unit. The annual production of the sub assembly component is 8,000 units indicating that the total cost incurred by the company in making the product in-house is $152,000 ($19 per unit * 8,000 units). The firm has an offer to procure the sub assembly component directly from an outside supplier at a price of $16 per unit. Prima facie it seems that the company will gain from buying the product as the cost per unit of buying the component is lower than the per unit cost of manufacturing the sub assemble component.

Here, comes into picture the relevant cost that should come into the picture. Fixed overheads are the costs which are unavoidable and continue to be incurred irrespective of the production. Here the total fixed overhead of the firm is $6 per unit out of which two-thirds represents executive salaries, rent, depreciation, and taxes, continue regardless of the decision, thus indicating that $4 ($6 * 2/3) will continue to apply for the company irrespective of making and buying decision and is thus irrelevant. The relevant fixed overhead thus remains at $2 ($6 - $4) per unit.

Now, considering the relevant fixed overhead of $2, the total costs for making the product stands at $15 per unit which is lower than the supplier offered price of $16.

The firm should thus continue to make the product.

Conclusion:

Cost and quality are the criteria which have the maximum impact, and are used by the companies to resolve tactical make-or-buy issues in order to achieve short-term cost savings or operational advantage. (Moschuris, 2015).

 Making or buying is a strategic decision and firms need to be careful in choosing between them. This is not as simple as it seems to be, there are nine dimensions to this decision. These dimensions are cross functionality, structure, regularity, formality, awareness, mandatory, information distribution and management and flexibility. (Moses and Ahlstorm, 2008).

Companies should consider all the factors including criticality, design, core competitiveness, functionality and the relevant cost for taking an informed decision of whether to buy or make.

References

Burt, D., Dobler, D. and Starling, S. (2003). World class supply management. Boston: McGraw-Hill/Irwin.

Inman, R. (2018). MAKE-OR-BUY DECISIONS. In: Encyclopedia of Management.

Moschuris, S. (2015). Decision-making criteria in tactical make-or-buy issues: an empirical analysis. EuroMed Journal of Business, 10(1), 2-20.

Moses, A. and Åhlström, P. (2008). Dimensions of change in make or buy decision processes. Strategic Outsourcing: An International Journal, 1(3), 230-251.

Sousa, F. (2012). The (Strategic) Make-or-Buy-or-Cooperate Decisions of the Firm. SSRN Electronic Journal Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2141714

Wilkison, J. (2013). Make-or-Buy Business Decision. In: WikkiCFO. The Strategic CFO. Retrieved from https://strategiccfo.com/make-or-buy-business-decision.