Lecture notes
Make or Buy Notes
- Module
- Management Accounting
- Institution
- University Of Reading (UoR)
Notes on Make or Buy, including descriptions and explanation of relevant costs.
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Some examples from this set of practice questions
1.
Name the 2 criteria for a cost to be relevant
Answer: 1) must not be sunk 2) must be different in each outcome
2.
Name a ceasing cost, that in every example is ceasing when you choose to make
Answer: Raw Materials
3.
Name a raising cost, that in every example is raising when you choose to buy
Answer: Cost to buy
4.
Raw materials is not a relevant cost in make or buy decisions. True or False Why?
Answer: False. Raw Materials are relevant as they are a differential cost. You only incur them if you make.
5.
Categorise this cost: If buy, a worker (direct labour), will be put on part-time work at 60% of their current salary. They can not be transferred to another department.
Answer: 40% is a ceasing cost. 60% is neither ceasing nor raising as they are being kept on, however, they provide no utility.
Content preview
Make or Buy‘Make or Buy’ is a decision between manufacturing a product internally, in house or purchasing it from an external
supplier (aka outsourcing). It compares the relevant costs associated with making the product against the relevant
costs of buying the product from externals.
Relevant costs for decision making:
For a cost to be relevant, it needs to satisfy both of these criteria (this is the same criteria for all of these types of
decisions, no just make or buy):
- must NOT be SUNK, past costs should not influence future decisions (e.g. the idea that you have already put so much
money into a car, should not influence you when deciding if getting a new car would be more convenient/cheaper for
you in the present time/future)
- MUST be a DIFFERENTIAL cost, must be a cost that is different from the alternatives (e.g. choosing between two jobs,
one located in an area with cheaper rent vs one located in an area where rent was higher)
Choosing Make or Buy
The quantitative analysis’ findings may be adequate to make a decision based on the most cost-effective technique.
Occasionally, qualitative analysis is used to address any concerns that a company cannot measure precisely.
Lack of in-house expertise, modest volume requirements, a desire for multiple sources, and the fact that the item may
not be vital to the firm’s strategy are all factors that may affect a firm’s decision to acquire a product rather than make
it itself.
If a company has the option to engage with a company that has successfully offered outsourced services in the past and
can maintain a long-term relationship, it may give it more thought. (However for our level we will only be considering
the quantitative analysis and use that to make our decision)
Similarly, existing idle manufacturing capacity, greater quality control, or proprietary technology has to be protected
may all influence a company’s decision to manufacture an item in-house. Concerns about the supplier’s reliability may
also be considered, especially if the product in question is vital to typical company operations. If a long-term agreement
is required, the company should also assess if the supplier can provide it.
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