@ 2012, Cengage Learning

Differential Analysis, Product Pricing, and Activity-Based Costing

LO 1c – Make or Buy Decisions and Replace Equipment Decisions

Make or Buy

Companies often manufacture products made up of components that are assembled into a final product. Should they make or buy the parts?

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If the make price of $280 is simply compared with the buy price of $240, the decision is to buy the instrument panel shown on the next slide. However, there are more factors to consider. Exhibit 7 on Slide 5 considers relevant costs in making this decision.

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Make or Buy

Make or Buy

An automobile manufacturer has been purchasing instrument panels for $240 a unit. The factory currently operates at 80% of capacity. The cost per unit of manufacturing a panel internally is estimated as follows:

Direct materials $ 80Direct labor 80Variable factory overhead 52Fixed factory overhead 68Total estimated cost per unit $280

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Make or BuyLO 1LO 1

Replace Equipment

On November 28, 2012, a business is considering replacing the following machine:

Old Machine:Book value $100,000Estimated annual variable

manufacturing costs 225,000Estimated selling price 25,000Estimated remaining useful life 5 years

(continued)

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Replace Equipment

The business is considering replacing the old machine with a new one, as shown below: Old New

Book value $100,000Cost of new machine $250,000Estimated annual variable

manufacturing costs 225,000 150,000Estimated selling price 25,000Estimated residual value 0Estimated remaining useful life 5 years 5 years

(continued)

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Replace EquipmentLO 1LO 1

replace old machine

Replace Equipment

The revenue that is forgone from an alternative use of an asset, such as cash, is called an opportunity cost.

Although the opportunity cost is not recorded in the accounting records, it is useful in analyzing alternative courses of action.

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Replace Equipment

Assume that the cash outlay of $250,000 for the new equipment, less the $25,000 proceeds from the sale of the present equipment, could be invested to yield a 10% return. Thus, the annual opportunity cost related to the purchase is $22,500 (10% * $225,000).

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