Xia Co. currently buys a component part for $7 per unit. Xia believes that making the part would require $3.15 per unit of direct materials and $1.15 per unit of direct labor. Xia allocates overhead using a predetermined overhead rate of 225% of direct labor cost. Xia estimates an incremental overhead rate of $0.70 per unit to make the part.
1-a. What are the relevant costs for Xia to make or buy the part?
1-b. Should Xia make or buy the part?

Question

19-12-2022
Business

Answered

Xia Co. currently buys a component part for $7 per unit. Xia believes that making the part would require $3.15 per unit of direct materials and $1.15 per unit of direct labor. Xia allocates overhead using a predetermined overhead rate of 225% of direct labor cost. Xia estimates an incremental overhead rate of $0.70 per unit to make the part.
1-a. What are the relevant costs for Xia to make or buy the part?
1-b. Should Xia make or buy the part?

Answer :

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smecloudbird18 smecloudbird18 · Answer 1 · 2022-12-22T06:26:04-05:00

a. Relevant Make Cost per unit $5.00
Relevant Buy Cost per unit $7.00
b. Xia should make the part as it will result in savings of $2 per unit. Any expense that is pertinent to a decision is what is meant by "relevant costs."

A matter is pertinent if the decision results in a change in cash flow. Additional sums that must be paid can influence the financial flow. Future cash flows, incremental costs, opportunity costs, and avoidable costs are the relevant costs. Expenses that will be impacted by a managerial choice are relevant costs. Relevant costs won't alter in the future regardless of which course of action you select. Sunk expenses, committed costs, and overheads are examples of irrelevant costs because they cannot be avoided.

To learn more about Expenses, click here.

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