Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 41

Make-or-Buy Decisions

Mel’s Meals 2 Go purchases cookies that it includes in the 10,000 box lunches it prepares and sells annually. Mel’s kitchen and adjoining meeting room operate at 70 percent of capacity. Mel’s purchases the cookies for $0.60 each but is considering making them instead. Mel’s can bake each cookie for $0.20 for materials, $0.15 for direct labor, and $0.45 for overhead without increasing its capacity. The $0.45 for overhead includes an allocation of $0.30 per cookie for fixed overhead. However, total fixed overhead for the company would not increase if Mel’s makes the cookies.

Mel himself has come to you for advice. “It would cost me $0.80 to make the cookies, but only $0.60 to buy. Should I continue buying them?” Materials and labor are variable costs, but variable overhead would be only $0.15 per cookie. Two cookies are put into every lunch.

Required

How would you advise Mel? Prepare a schedule to show the differential costs.

Step 1 of 4

Differential costs:

The differential cost is calculated as the difference between two different decisions and of different level of outputs. The concept is used when there are several possible options to follow and only one option could be selected and others are dropped.