Question

Meridian Ltd makes 30,000 units per year of part AS400 used in the range of electrical goods it manufactures.

The unit costs of this part are as follows;
Direct Materials 24.70$
Direct Labour 16.30$
Variable manufacturing overhead 2.30$
Fixed manufacturing overhead 13.40$
Total 56.70$

An outside supplier has offered to supply Meridian Ltd with as many of these parts as it needs, for £44.50 each. If the part were purchased from the outside supplier, all direct labour costs associated with the product could be avoided, but in the short term, all fixed overhead costs would have to be reapportioned over the remaining product range.

Required;
a) Calculate the relevant cost per unit of part AS400 in relation to the decision of whether to make or buy in the part.

b) If Meridian accept the offer to purchase the part from the outside supplier, the production facilities now being used to make the part could be used to make 4,000 more units of its best selling product, each of which generate a contribution of £11. Taking into account this additional information, what is the total additional cost or saving of purchasing 30,000 units per year of AS400 rather than making it?

c) “The easiest way to distinguish between relevant & non-relevant costs is by cost behaviour; variable costs are relevant costs & fixed costs are not.” Explain briefly why you might agree or disagree with this statement.

Answer 1

a)

Relevant Cost
Direct Materials Per unit	$    24.70
Direct Labor	$    16.30
Variable manufacturing overhead	$       2.30
Relevant manufacturing cost	$    43.30

2)

Additional contribution margin	$          44,000.00
Manufacturing cost savings	$    1,299,000.00
Cost of purchasing the part	$ (1,335,000.00)
Net Saving	$            8,000.00

3) Relevant cost, in managerial accounting, refers to the incremental and avoidable cost of implementing a business decision and it can be Fixed Costs and it can be variable cost