Cost Accounting (14th Edition)

398 CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION
the chip itself. In contrast, to maintain the secrecy of its formula, Coca-Cola does not outsource
the manufacture of its concentrate.
Example 2: The Soho Company manufactures a two-in-one video system consisting
of a DVD player and a digital media receiver (that downloads movies
and video from internet sites such as NetFlix). Columns 1 and 2 of the following
table show the expected total and per-unit costs for manufacturing the
DVD-player of the video system. Soho plans to manufacture the 250,000 units
in 2,000 batches of 125 units each. Variable batch-level costs of $625 per
batch vary with the number of batches, not the total number of units produced.
Expected Total Costs of
Producing 250,000 Units in
2,000 Batches Next Year
(1)
Expected Cost per Unit
(2) = (1) ÷ 250,000
Direct materials ($36 per unit * 250,000 units)
$ 9,000,000 $36.00
Direct manufacturing labor ($10 per unit *
250,000 units)
2,500,000 10.00
Variable manufacturing overhead costs of power
and utilities ($6 per unit * 250,000 units)
1,500,000 6.00
Mixed (variable and fixed) batch-level
manufacturing overhead costs of materials
handling and setup [$750,000 +
($625 per batch * 2,000 batches)]
2,000,000 8.00
Fixed manufacturing overhead costs of plant
lease, insurance, and administration ƒƒ3,000,000 ƒ12.00
Total manufacturing cost $18,000,000 $72.00
Broadfield, Inc., a manufacturer of DVD players, offers to sell Soho 250,000 DVD
players next year for $64 per unit on Soho’s preferred delivery schedule.
Assume that financial factors will be the basis of this make-or-buy decision.
Should Soho make or buy the DVD player?
Columns 1 and 2 of the preceding table indicate the expected total costs and expected cost
per unit of producing 250,000 DVD players next year. The expected manufacturing cost
per unit for next year is $72. At first glance, it appears that the company should buy DVD
players because the expected $72-per-unit cost of making the DVD player is more than
the $64 per unit to buy it. But a make-or-buy decision is rarely obvious. To make a decision,
management needs to answer the question, “What is the difference in relevant costs
between the alternatives?”
For the moment, suppose (a) the capacity now used to make the DVD players will
become idle next year if the DVD players are purchased and (b) the $3,000,000 of fixed
manufacturing overhead will continue to be incurred next year regardless of the decision
made. Assume the $750,000 in fixed salaries to support materials handling and setup will
not be incurred if the manufacture of DVD players is completely shut down.
Exhibit 11-6 presents the relevant-cost computations. Note that Soho will save
$1,000,000 by making DVD players rather than buying them from Broadfield. Making
DVD players is the preferred alternative.
Note how the key concepts of relevance presented in Exhibit 11-3 apply here:
Exhibit 11-6 compares differences in expected total future revenues and expected
total future costs. Past costs are always irrelevant when making decisions.
Exhibit 11-6 shows $2,000,000 of future materials-handling and setup costs under
the make alternative but not under the buy alternative. Why? Because buying DVD
players and not manufacturing them will save $2,000,000 in future variable costs per
batch and avoidable fixed costs. The $2,000,000 represents future costs that differ
between the alternatives and so is relevant to the make-or-buy decision.