A large company has started manufacturing the heavy duty bearing that is utilized in its most liked line

of skateboards.
The business’ accounting section reports the following expenses for manufacturing 8000 units of the bearings
internally every year.

Direct Materials ₹6 x 8000 = ₹ 48,000

Direct Labour ₹4 x 8000 = ₹ 32,000
Supervisor’s Salary ₹3 x 8000 = ₹ 24,000

Variable Overhead ₹1 x 8000 = ₹8,000

Allocated general overhead ₹5 x 8000 = ₹40,000

Depreciation of special equipment ₹2 x 8000 = ₹16,000

Total Expense ₹21 x 8000 = ₹168,000

An external supplier offered to sell 8000 bearings to the skateboard company for only ₹19 per bearing. Should the
business cease manufacturing the bearings internally or instead, purchase them from an external supplier?

SOLUTION:
If the expenses that can be avoided by buying bearings from the external supplier amount to less than ₹19, the
business must continue to manufacture its bearings and reject the external supplier’s offer. On the other hand, if the
expenses that can be prevented by buying the bearings from the external supplier amount to more than ₹19, the
external supplier’s offer should be accepted.
Total applicable/avoidable expense for Making 8000 units:

Direct Materials ₹6 x 8000 = ₹48,000

Direct Labour ₹4 x 8000 = ₹32,000
Supervisor’s Salary ₹3 x 8000 = ₹24,000
Variable Overhead ₹1 x 8000 = ₹8,000
Allocated general overhead not relevant
Depreciation of special equipment not relevant
Total Expense ₹14 x 8000 = ₹112,000

Total expense for Buying 8000 Units:

Outside purchase expense ₹19 x 8000 = ₹152,000

The difference of ₹40,000 supports continuing to make 8000 units.

Keep in mind that depreciation of special equipment is mentioned as one of the expenses for manufacturing the
bearings internally. Owing to the fact that the equipment has already been bought, this depreciation is a sunken
expense and is, therefore, not applicable. If the equipment could be utilized to create another product, this may be a
relevant expense as well. Still, we suppose that the equipment has no salvage value and no other use.
In addition, the company is setting aside a part of its general operating expenses, for bearings. Any part of the general
operating expenses that would be done away with if the bearings were bought instead of made would be pertinent in
this analysis. However, the general operating expenses are possibly a common expense to all the company’s goods
produced in the factory and which would continue without changes even if the bearings were bought from outside (is
not relevant).

https://www.cleverism.com/make-or-buy-decision-step-by-step-guide/
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