Question

Question 4:

McKinson Publishers produces the book covers for its hardbound books. Recently, Marliss Book Binders purchased new robotic equipment that cutsm trims and prints book covers in one process. Marliss offered to provide book covers for McKinson at $1.45 per book. Daniel Nguyen, the management accountant for McKinson Publishers, analyses the cost information for internally producing hardbound book covers as follows:

		Total costs for
		200,000 book covers		Cost per unit
Direct materials		$100,000		$0.50
Direct labour		$80,000		$0.40
Manufacturing overhead		$100,000		$0.50
Supervisor's salary		$90,000		$0.45
Total cost		$370,000		$1.85

After summarising the costs for producing the book covers in-house, Daniel needs to identify costs that are relevant and irrelevant to the decision. First, he collects more information. He learns from the production manager that the supervisor could be laid off if the book covers are outsourced. As a management accountant, Daniel already knows that manufacturing overhead is an indirect cost. In this case, it is allocated to books based on the number of direct labour hours used in each production process. Overhead costs will be incurred even if the book covers are outsourced. However, after examining past utility bills, Daniel estimates that closing off the part of the plant where book covers are produced would save about $30,000, or $0.15 per book cover.

Required:

a) Identify and explain which costs are relevant and irrelevant to this make-or-buy decision of McKinson.

Answer 1

CALCULATION OF MAKE COST PER UNIT

PARTICULARS AMOUNT NATURE

DIRECT MATERIAL $0.5 PER UNIT RELEVANT

DIRECT LABOUR $0.4 PER UNIT RELEVANT

SUPERVISOR SALARY $0.45 PER UIT RELEVANT

MANUFACTURING OVERHEAD $0.35 PER UNIT RELEVANT

TOTAL COST PER UNIT $1.7 PER UNIT

COST OF PURCHASE $1.45 PER UNIT

SO IT IS ADVISABLE TO BUY FROM OUTSIDE RATHER THAN MAKE IN THEIR OWN COMPANY

WORKING NOTE

DIRECT MATERIAL IS RELEVANT COST BECAUSE IT IS VARIABLE COST

DIRECT LABOUR IS RELEVANT COST BECAUSE IT IS VARIABLE COST

SUPERVISOR SALAY IS RELEVANT BECAUSE IT IS AVOIDABLE IF THE COMPANY DOES NOT PRDUCE IN THE OWN PLANT

MANUFACTURING OVERHEAD RELEVANTS ARE 0.35 (0.5-0.15) SINCE THE PRODUCING COMPANY CAN SAVE 0.15$ SO IT IS DEDUCTED FROM THE COST PER UNIT