Accounting 2301 - Chapter 14: Make or Buy Decisions

Introduction

• Focus on learning objective three: Analyzing make or buy decisions.
• Relevant for manufacturing companies that can choose to make a product/component or buy it.

Make or Buy Decision

• Key question: Should a company manufacture a component themselves or purchase it from another manufacturer?
• The decision affects the company's bottom line.

Case Study: Barron Company

• Scenario: Motor scooter manufacturer producing 25,000 ignition switches annually.
• Current Cost Structure:
  • Total cost for 25,000 switches: $225,000 ($9 per unit)
  • Direct materials, labor, variable, and fixed manufacturing overheads considered.
• Alternative Option: Buy switches at $8 per unit.
  • Savings in fixed overhead costs: $10,000.

Analysis of Costs

• Fixed Manufacturing Overhead: Originally $60,000, reduced by $10,000 if switches are bought.
• Cost Comparison:
  • Making: $225,000 total cost.
  • Buying: $200,000 for purchase + $50,000 remaining fixed costs = $250,000.
• Conclusion: Despite the lower unit cost when buying, making is cheaper due to partial retention of fixed costs.

Opportunity Costs

• Defined as the potential benefits lost when choosing one option over another.
• Example:
  • Employees, equipment, and space currently used for making switches might be repurposed to generate additional income ($38,000).
  • This potential income is considered an opportunity cost when deciding to continue making.

Impact of Opportunity Costs on Decision

• Revised Cost Evaluation:
  • Making: $225,000 + $38,000 (opportunity cost) = $263,000.
  • Buying: $250,000 (unchanged)
• Decision: Buying becomes the favorable option as it increases net income by $13,000.

Conclusion

• Consider both direct costs and opportunity costs in make or buy decisions.
• The decision should involve minimizing total costs to maximize profits.
• Opportunity costs can significantly impact the decision-making process and outcome.

These notes capture the key points and analysis discussed in the Accounting 2301 Chapter 14 video on make or buy decisions, emphasizing how both fixed and opportunity costs affect these decisions.