- 15 Marks
MA – L2 – Q36 – Decision Making Techniques
Question
Akroma Ghana Limited has a machine with which it produces Item A. Ten (10) machine hours are required to produce the item. This product’s selling price is GH₵150 with a variable cost of GH₵60. The company has just received an order for the supply of Item B. Each unit of Item B will require four (4) machine hours. The annual quantity of Item B required is 12,000 units and the cost estimates for the quantity is given below:
| GH₵ | |
|---|---|
| Direct material | 125,000 |
| Direct wages | 52,000 |
| Variable overheads | 58,000 |
| Floor space occupancy | 11,500 |
| Depreciation | 7,500 |
| Salary of Inspector for Item B alone | 10,000 |
| Total Cost | 264,000 |
It was noted that Item B could be outsourced from a supplier at a cost of GH₵28 per unit.
You are required to assist management to decide whether to produce Item B internally or to buy from an outside supplier if the following conditions exist:
(i) Production of Item B will not in any way disturb the production of Item A.
(ii) The machine producing Item A is already fully engaged.
(B) List any FIVE steps in the management decision-making process.
Answer
(a) Incremental cost of producing Item B
| Total GH₵ | Per unit GH₵ | |
|---|---|---|
| Direct Material | 125,000 | 10.42 |
| Direct labour | 52,000 | 4.33 |
| Variable Overhead | 58,000 | 4.83 |
| Salary of Inspector | 10,000 | 0.83 |
| TOTAL | 245,000 | 20.41 |
Cost of buying from outside = GH₵28 × 12,000 UNITS = GH₵336,000
(i) If the production of Item B will not affect Item A, it is advisable to produce internally as the production cost is less than the cost of buying/purchasing from outside supplier i.e. GH₵336,000 – GH₵245,000 = GH₵91,000.
(ii) If the production of Item B will affect production of Item A, we need to consider the contribution of Item A not produced as well as the incremental costs of Item B.
Contribution per unit of Item A = GH₵150 – GH₵60 = GH₵90.
Contribution per machine hour of Item A is therefore GH₵90 ÷ 10 hrs = GH₵9/hr
Total contribution lost by not using the machine for Item A = 12,000 units × 4 hrs × GH₵9/hr = GH₵432,000
Computation of savings or loss for producing Item B if capacity is full is as follows:
| Total GH₵ | Per unit GH₵ | |
|---|---|---|
| Incremental cost of producing Item B | 245,000 | 20.42 |
| Opportunity cost of failing to produce Item A | 432,000 | 36.00 |
| 677,000 | 56.42 | |
| Price offered by outside supplier | 336,000 | 28.00 |
| Loss from internal production | 341,000 | 28.42 |
Decision
We advise the company to buy and not to produce internally since it is currently working at full capacity.
(b)
(i) Determine the specific objectives as desired by management
(ii) Understand the scope and validity of factual knowledge
(iii) Determine relevant costs
(iv) Ascertain alternative courses of action
(v) Select an alternative or choice making
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