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Make Or Buy Decision Example Accounting

Step 1: PlanThe make-or-buy decision process begins with strategic planning at the top level. The senior management dedicates qualified personnel or forms a separate team for decision-making.

make or buy decision example accounting


There are, as we have discussed, so many variables to each decision we make. The examples are simplified, but think through some of the other situations that may arise with each decision you are asked to make!

A make-or-buy decision refers to an act of using cost-benefit to make a strategic choice between manufacturing a product in-house or purchasing from an external supplier. It arises when a producing company faces a diminishing capacity, experiences problems with the current suppliers, or sees changing demand.

The make-or-buy decision compares the costs and benefits that accrue by producing a good or service internally against the costs and benefits that result from subcontracting. For an accurate comparison of costs and benefits, managers need to evaluate the benefits of purchasing expertise against the benefits of developing and nurturing the same expertise within the company.

The make-or-buy decision is sometimes treated as a financial or accounting decision. While it is important to conduct an accounting assessment and settle for the low-cost approach, it is more crucial to understand the basis of the decision.

One of the most notable advantages that a company enjoys when embracing a make-or-buy decision approach is that it can lower costs and increase capital investments, regardless of whether it decides to make materials in-house or subcontract from an external vendor.

A rigorous make-or-buy analysis can also act as a source of competitive advantage. For example, a company can increase the value it delivers to customers and shareholders from its core service and skills. It can also stay flexible by adopting a make-or-buy decision approach.

Make-or-Buy decision (also called the outsourcing decision) is a judgment made by management whether to make a component internally or buy it from the market. While making the decision, both qualitative and quantitate factors must be considered.

Definition: The make or buy decision analysis is an evaluation of manufacturing something in-house versus buying that product from another seller. In other words, it is when a business weighs the pros and cons of making or doing something within the business using company resources or outsourcing that part of production or business function to an outside party.

What is the definition of make-or-buy decision? The make vs buy decision traditionally relates to parts in a manufacturing process. If an organization finds that they can make one or more of the manufacturing inputs that they use in house, then the organization should evaluate the cost and compare it to the cost of purchasing those inputs elsewhere.

However, a company also has to make this decision as it relates to building software or carrying out business functions. For example, if an organization needs a certain type of software but does not have the IT resources necessary to build it in-house, then it makes sense for the business to look outside of the business to purchase this software.

This question relates to a buy-or-make decision, which is the act of making a strategic choice between producing an item in-house or buying it from a supplier, which is also referred to as outsourcing.

My father owns a small business printing and signs business. He faces make-or-buy decisions regularly. A prime example relates to the creation of training booklets for one of his largest accounts, a local industrial manufacturer. My father prints the books efficiently in-house, but the binding process often entails utilizing a vendor, especially for large orders. It is simply too labor-intensive and costly for my father to bind large book orders internally. In these situations, it's usually more effective to outsource the job to a large vendor with specialized binding equipment.

There are pros and cons of both make and buy decisions. It is crucial to have a process to help you make the right decision for each deliverable or project element. A make or buy analysis can help you be cost-efficient and consider potential future benefits for your project team or company.

The make-or-buy decision is the action of deciding between manufacturing an item internally (or in-house) or buying it from an external supplier (also known as outsourcing). Such decisions are typically taken when a firm that has manufactured a part or product, or else considerably modified it, is having issues with current suppliers, or has reducing capacity or varying demand.

To come to a make-or-buy decision, it is essential to thoroughly analyze, all of the expenses associated with product development in addition to expenses associated with buying the product. The assessment should include qualitative and quantitative factors. It should also separate relevant expenses from irrelevant ones and consider only the former. The study should also look at the availability of the product and its quality under each of the two situations.

Quantitative aspects can be calculated and compared whereas qualitative aspects call for subjective judgment and, frequently require multiple opinions. In addition, some of the associated factors can be quantified with sureness while it is necessary to estimate other factors. The make-or-buy decision calls for a thorough assessment from all angles.

As mentioned earlier, distinguishing between these two kinds of expenses is necessary to come to a make-or-buy decision. Relevant costs for manufacturing the good are all the expenses that could be avoided by not manufacturing the product in addition to the opportunity cost resulting from utilizing production facilities to manufacture the good as against the next best alternative utilization of the manufacturing facilities. Relevant costs for buying the product are all the expenses relating to purchasing a product from suppliers. Irrelevant costs are the expenses involved irrespective of whether the good is produced internally or bought externally.

Carry out the quantitative analysis by comparing the expenses incurred in each option. The expense of purchasing products is the price paid to suppliers to purchase them. On the contrary, the cost of manufacture includes both variable and fixed expenses. For example, a business requires 10 units of its item in 10 consecutive periods. The company can either buy the units at $100 per unit or expend $1,000 to set up manufacture facilities and $8 to manufacture each unit. As the business expends $10,000 to buy the products and $9,000 to manufacture the same quantity of products, with respect to make-or-buy, the business would do better to manufacture the goods, on the basis of only quantitative factors.

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? To arrive at a make-or-buy decision, the focus should, at all times, be on the relevant costs (the ones that differ between the alternatives). The expenses that differ between alternatives comprise the expenses that could be prevented by buying the bearings from an external supplier.

In conclusion, it may be said, the make-or-buy decision is a very important decision with respect to overall production strategy and the possible implications for asset levels, employment levels and key competencies. Business accounting may appear to be an easy set of equations mirroring the money that enters into a business and that which flows out from it. However, in reality, there are countless intricacies associated with the relationship between various kinds of income and costs. Complexity is particularly obvious in make-or-buy. Considering these aspects, the make-or-buy decision should be weighed with utmost care.

Types of decisionWe will now look at some typical examples where you have to decide which costs are relevant to decision-making. We suggest that you try each example yourself before you look at each solution. In all examples we ignore the time value of money.

Example 7: Make or buy decisionA company makes a product which requires two sequential operations (Operation 1 and Operation 2) on the same machine. The machine is fully utilised. Material costs $12 per unit.

The make-or-buy decision is a choice that product-oriented businesses face: Should the business make particular units (products or component parts) in-house, or should they buy them from a supplier? Both advantages and disadvantages of the make-or-buy decision exist.

You may recognize this situation as being similar to outsourcing decisions made regarding employees and services, and sometimes make-or-buy decisions are referred to as outsourcing. However, as the Corporate Finance Institute explains, the manufacturing version of the choice includes its own unique benefits that growing companies should understand as they start forming long-term strategies.

The majority of make-or-buy decisions tend to be cost decisions: Businesses want to learn which choice presents the most cost advantages with the fewest downsides. Sometimes suppliers can provide key parts or products at a significant discount compared to what it costs a business to produce those in-house, saving the company money with relatively few downsides.

No determinant answer to the lease versus buy debate exists in this example. For some companies, purchasing the office space is more feasible for the addition of an asset and less overall expense. For others, a lease makes more sense to leave more cash for business growth and the added flexibility due to the ease of renegotiating a lease.

With make or buy decisions, we will once again use a contribution margin approach. Separate variable product costs from fixed product costs. How do the variable costs of producing the product compare to the cost of purchasing the product from another company. At first glance, it may appear that the cost of the outsourced product is higher because the variable costs of making the product are lower. However, all costs should be considered. 041b061a72


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