Question

Al Maha Co. produces 1,200 units of petroleum with direct materials costs of RO 32,000, Direct Labor costs of RO 12,000, Variable Overhead costs of RO 25,000 and Fixed Overhead costs of RO 22,000. Oman Oil Co. offers to produce the units of petroleum at RO 72 per unit.

Instructions

a. Prepare the incremental analysis for the decision to make or buy the petroleum.

Answer 1

If AL Maha Co produce the oil the cost of making is below:

Particulars		Amount in RO
Material Cost		32000
Direct labour		12000
Variable Overhead		25000
Fixed Overhead		22000
		91000
Units to be produced		1200
Cost per Unit		75.83

If Oman Oil produce at RO 72 per unit.

If Maha Al Co buys the oil from the Oman oil then it is not advisable to buy the oil from Oman.

There is a loss as If Maha Al Co buy from Oman oil then cost of Oil will be Ro 72 and the fixed overhead the company will be incurring irrespective of production of oil.

Cost if buy from Oman Oil :

Cost = RO 72

Fixed Overhead = RO 22000/1200 units = RO 18.33

Therefore total cost 72 + 18.33 = 90.33

Therefore it is advisable for Maha Al co to make the oil as it will cost 75.83 where as if the company buys from Oman oil the cost will be RO 90.33