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Relevant Cost Case Behemoth Motors Corp 1
Relevant Cost Case Behemoth Corp
Make or Buy Decision
This kind of choice is frequently known as a 'make or buy' decision since it is a choice made on the basis of whether a particular company should continue manufacturing a certain product or opt to buy the product from an outside source. The manufacture measure of the choice is known as in-sourcing and the choice based on buying from outside is known as outsourcing. These choices mostly involve the buying of goods and services (Brian, 2010).
- When there are no Limiting Factors
The decision concerning in-sourcing or outsourcing of a given product or services is one that every business must face at a certain point. It is often one of the most important decisions for management for the critical effect it has on profitability (Brian, 2010). This decision is very delicate for the management accountant who is the sole provider of the cost data on which the choice is eventually based. This in-sourcing and outsourcing problem involves a choice by an organization on whether it ought to manufacture a product or provide a service with its own accessible resources or whether it ought to pay another organization to provide the service or product (Brian, 2010). The possibility of manufacturing gives the management substantial control over the general manufacture or service provision, but the outsourcing alternative may have great advantages in that the external organization may have greater experience and skills in the specific work making it cheaper (Brian, 2010).
During certain situations, in-sourcing or outsourcing choice is not really a choice at all. Meaning in some situations, there is no substitute to manufacturing thus implying the product design is private or the methods of processing are a trade secret (Brian, 2010). In some instances, patents held by suppliers may disqualify the usage of certain methods, thus, implying that there are no choices available other than outsourcing or opt to do without. The seller who has created a distinctive proficiency or who utilizes particular paraphernalia may manufacture better quality work making the decision making process easy i.e. opting to outsource rather than in-sourcing. In some situations, the distinct qualities necessitated in the merchandise may not exist outside and so make decision becomes necessary (Brian, 2010).
Where technical concerns do not affect the make or buy decision, the decision develops to one of choosing the least-cost substitute in each choice state. The use of comparative data is necessary, consequently, to decide whether it is cheaper to in-source or to outsource (Brian, 2010). Generally, this entails assessment of the particular marginal costs or, in particular situations, the incremental costs of each alternative. Incremental costs are applicable in choices which comprise of capacity changes. For instance, if a particular section has always been outsourced since plant and equipment’s have not been installed in the company (Brian, 2010). When bearing in mind the alternative to outsourcing, the cost of manufacturing comprises all the incremental costs (which includes fixed expenditure) arising from the choice. The incremental cost also comprises the opportunity cost of the venture in capital equipment, meaning the projected return from an alternate investment opportunity. A choice to outsource part of business that has earlier been manufactured may release capacity for disposal so that the incremental cost of the choice also comprises the appropriate fixed cost savings (Brian, 2010).
- When there are Limiting Factors
The reason for outsourcing products/services from another organization is the lack of means or resources, so that the corporation might be able to manufacture all its components. During such scenarios the company should combine interior resources with outsourcing to increase profitability. In a state where a corporation must outsource services to make up for the lack of in its manufacturing ability, then its cost will be reduced where the marginal cost of procurement is minimum for each unit of scarce resource saved through outsourcing (Brian, 2010).
Brief Description of All Costs
According to Jay (2004), below is a list of all the costs.
Fixed overheads; these are the costs incurred irrespective of the decision made.
Notional costs; these are the costs that are not representative of real cash flow.
Sunk costs; these are the costs that have already been incurred in the past thus they have no effect on future decision making.
Book values; these costs are compatible to sunk costs.
Direct materials These costs are incurred on all material purchased to carry out a specific task.
Direct labor These costs are incurred in the labor needed in making a particular product. The remuneration package for workers can be incurred directly to the product thus indicating direct labor.
Direct expenses These are the additional costs outside direct labor costs or direct material costs that are usually incurred in the production process of a particular product.
Production overheads These is the general categorization of all indirect expenditure and costs incurred.
Administration overheads these are the costs incurred in the process of directing, controlling and everyday administration of a particular firm.
Selling and distribution overheads these are the costs incurred on selling and distributing of goods to the target customers.
The Relevant Costs for Non-scheduled Decision Making
Relevant costs are very fundamental when making specific decision in management. For costs to be considered, they ought to be;
Futuristic – In decision making process, the decision should be about the future and not want has occurred in the past. Any incurred cost is therefore considered irrelevant to any decision made currently (Brian, 2011).
Relevant costs are usually cash flows-The relevant costs will differ among various alternatives. These decisions are assumed they would lead to the maximization of the satisfaction levels of organization’s owners therefore they ought to be prioritized (Brian, 2011).
The Relevant costs emerge as a direct result in decision making. They ought to be incremental costs i.e. Differentiation between decision making cost and cost without decision (Brian, 2011).
In the process of decision making, costs’ that differ among the available alternatives and will have influence on the relevant cost results. As for Relevant revenue, the revenues that differ among the available alternatives will spearhead the end outcome (Brian, 2011). The Future costs and revenues are important in the decision making process since planning is usually futuristic in nature. Costs that have been used in the past like sunk costs, are not relevant for decision making. Other costs that do not differ are fixed overheads, notional costs and book values (Brian, 2011).
Costs and Revenues differentiation
Costs and revenues that are capable of altering the outcome of a decision are relevant. In a situation where factors are similar to all alternatives, one can choose to ignore since only the differences can be considered relevant. The Differential costs can be avoided if any decision is made (Brian, 2011).
Avoidable costs: These are the costs that will not be incurred if a specific decision is reached. It’s mostly in the scope of a fixed cost e.g. a fixed cost can be recognized in the production of a particular product and if production is halted, the fixed cost will be avoidable since it will not be incurred (Agrawal, 2010).
Incremental costs: This is the extra cost incurred due to the outcome of a particular decision e.g. when a decision is made to boost production and for that to be possible an additional machine ought to be leased, the costs of leasing the machine is incremental thus considered to be relevant (Agrawal, 2010).
Opportunity costs: These are costs that measure the opportunity that is lost when the choice of a particular course of action entails giving up an alternate course of action (Agrawal, 2010).
Analysis of the Reliable Costs
When the firm opts to make the product, the cost of direct labor will be $ 16,800 per month. If the firm chooses to outsource or to do special orders, it will incur a penalty charge of $5500 per month for the replacement of the labor force. These costs are usually futuristic cost that will be affected the decision making process thus making them relevant. If an accountant was expected to choose, he would opt for the minimum costs thus will opt to outsource and incur the $5500 monthly penalty charge (Jay, 2004).
Direct Materials The 8000 units of materials are already in stock. The decision of getting into a special contract would entail buying form locals on a monthly basis thus there is no certainty if the buying price will remain the same. Currently, the cost cannot be determined thus assumption was made that the cost will be $ 165 similar to the make decision cost. These material costs are relevant if they are in constant use by a firm (Jay, 2004).
Qualitative factors that result to Decision Making
Foreign currency translation
For any firm that opts to sell goods or services in different countries other than the home country, two important decisions ought to be considered.
The firm will evaluate the decision of either creating the good or service in its home country then export it abroad or opt to create a good or service using its subsidiaries abroad.
The firm will evaluate its options on whether it should structure its transactions for all cash flows to occur as per the currency of the home country or alternatively, that of the foreign country (Agrawal, 2010).
Tax Laws Between two countries
The tax laws of these two countries ought to be put into consideration to avoid a situation that may result to double taxation (Agrawal, 2010).
Stability of Government
This is very important especially when outsourcing. A stable government can boost confidence in an economy and this will make business activities to thrive (Agrawal, 2010).
Reliability and Quality of Workforce
In any business operation, if a firm has reliable and highly skilled workforce, they are likely to steer a company towards success (Agrawal, 2010).
Reliability of Sources and Quality of Materials
The two factors complement each other. If the suppliers are reliable, they will ensure the appropriate materials are delivered on time. The more the suppliers deliver quality materials, the more the firm will meet customer requirement and in hand, improve customer satisfaction (Agrawal, 2010).
Reliability of Transportation and Communication
Reliable transportation means convenience in delivery of various commodities. Communication on the other hand, entails finding out whether the transport operations are being conducted appropriately and this can be spearheaded by an effective feedback system. When there is emphasis on reliability, goods will get to their destination at the right time (Agrawal, 2010).
The company has analyzed the costs and it has established that it will easier to stick to manufacturing rather than outsourcing from a foreign company. The operating income obtained from opting to manufacture is substantially higher than what the company would obtain from outsourcing.
Agrawal, N. K. (2010). Principles of Management Accounting, Global Media (read chapter 6),
from library portal.
Brian, Routh. Decision Making & Relevant Information (2011). This series of videos explains
topics of decision making process. It is an excellent introduction and overview of relevant information. You can find other useful videos in related links.
Jay, B., (2004). Relevant costs for decision-making, Retrieved from: