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MAKE OR BUY
X Company, a manufacturer of furniture sets, is considering to purchase the seat cushions needed for
its chair. The expected purchase price of these seat cushions is P50 per unit.
If it would continue to produce these cushions, the company expects to incur the following costs:
Raw Materials P13 Direct Materials P13
Direct Labor 15 Direct Labor 15
Variable Overhead 5 Variable Overhead 5
Fixed Overhead (based on the Total variable manufacturing cost per unit 33
average production x No. of units 10,000 units
requirement of 10,000 units) 20 Total variable manufacturing cost per unit P330,000
Total production cost per unit P53
MAKE BUY
Direct Materials (P13x10,000) P130000 Purchase Price P50
Direct Labor (P15x10,000) 150000 x No. of units 10,000
RELEVANT
Variable Overhead (P5x10,000) 50000
Total variable manufacturing cost P330000 Total Purchase Costs P500,000
Fixed FOH (P20x10,000) 200000 Fixed FOH 200,000 IRRELEVANT
Total Cost P530000 Total Cost P700,000
*Assume that materials and labor costs are expected to increase by 20% next period. Factory
overhead will be eliminated in case the company decides to buy the seat cushions from other
suppliers. Moreover, the facilities presently being used in the manufacture of seat cushions can be
utilized to manufacture another part of the main product in case such facilities become vacant when
the company decides to stop producing the seat cushions. This alternative use of resources would
result into cost savings of P100,000 for X Company. Assume further that the companys requirement
for seat cushions is expected to increase by 4,000 units next period.
Forecast data:
No. of units 10,000 + 4,000 14,000 units
materials P13 x 120% P15.60
Labor P15 x 120% P18.00
Relevant Manufacturing costs:
Materials (P15.30x14000) P218400
Labor (P18.00x14000) 252000
Variable Overhead (P5.00x14000) 70000
Fixed overhead (P200000x40%) 80000 P620400
Less net purchase costs:
purchase cost (P50x14000) P700000
Less savings from alternative use of facilities 100000 600000
Net advantage of buying the seat cushions P20400
Materials P10
Labor 12
Variable Overhead 8
Fixed Overhead (P60000/20000) 3
Variable selling and admin costs 7
Fixed selling and admin costs (P40000/20000) 2
Total unit costs P42
Special Selling price (P50x70%) P35
Less relevant costs:
Materials P10
Labor 12
Variable overhead 8 30
Marginal profit P5
x No. of units ordered 3000
Incremental profit from accepting the special order P15000
*X Companys normal capacity is 60000 units. Since the past few months, it has utilized only one half
of this capacity. For Last month, the result of its operations is summarized: