Relevant costs for a make or buy decision include all of the following EXCEPT:
- fixed salaries that will not be incurred if the part is outsourced
- payroll tax (unemployment insurance costs) b/c of outsourcing
- material handling costs that can be eliminated if the part is outsourced
- special machinery for the part that has no resale value
- current direct material costs for the part
The correct answer and explanation is :
The correct answer is “current direct material costs for the part”.
Explanation:
In a make or buy decision, a company evaluates whether it should produce a product in-house (make) or outsource it (buy). The decision requires a focus on relevant costs, which are costs that will change as a result of the decision and are therefore crucial for comparison. The goal is to identify costs that will differ depending on whether the part is made internally or purchased from an external supplier.
Let’s look at the options:
- Fixed salaries that will not be incurred if the part is outsourced: This is a relevant cost. If outsourcing the production results in avoiding certain fixed salaries, then these costs should be considered. These salaries are incremental costs that are saved if the part is outsourced.
- Payroll tax (unemployment insurance costs) because of outsourcing: This is also a relevant cost. If outsourcing results in new payroll tax obligations (such as unemployment insurance costs for workers), these should be included because they will only occur due to the outsourcing decision.
- Material handling costs that can be eliminated if the part is outsourced: This is another relevant cost. If material handling costs, such as storage or transportation costs, can be eliminated by outsourcing, these are savings that should be factored into the decision.
- Special machinery for the part that has no resale value: This is relevant. If a company has specialized machinery that would no longer be used if the part is outsourced, the costs related to that machinery (such as maintenance or depreciation) are relevant. Additionally, the lack of resale value implies there is no offset to those costs from selling the machinery.
- Current direct material costs for the part: This is not a relevant cost. Direct material costs are typically relevant in the context of production decisions. However, in the make or buy decision, if the part is outsourced, these material costs will no longer be incurred by the company. The relevant costs here are the costs of purchasing the part externally, not the current material costs used in internal production.
In summary, current direct material costs for the part are considered sunk costs in this decision since the costs will be replaced by the purchase price if the part is bought instead of made. Therefore, they are irrelevant to the make or buy decision.