Your Ask Joey ™ Answer

How to perform a make vs buy analysis?

Make vs buy is a concept tested on the BEC section of the CPA exam, but it is also a type of analysis that real world companies perform daily. Just as it sounds, in a make vs buy analysis, a company is trying to determine whether they should continue to manufacture a part in-house or buy it from a supplier. Companies have to make these decisions every day and they should consider qualitative and qualitative factors:

Some companies will look purely at the cost. Is it cheaper to make the product or is it cheaper to buy it from a supplier. Other companies will consider qualitative factors such as reputation, reliability, and other pros or cons. On the CPA exam, the decision will most likely be driven by cost as that is a very objective point of view. However, in the real world, qualitative factors should be considered, but those are more subjective and every company will have a different view on what qualitative factors are relevant.

Example of Make vs Buy Analysis

Let’s take a look at an example as learning to apply a topic is the best way to master a concept.

Zire, an electric car company, is considering outsourcing one of the component parts for its product. The company currently makes 10,000 parts per month. The company incurs total direct materials of $40,000, total direct labor of $30,000 and total fixed factory overhead of $20,000.

Zire decides to purchase the part for $8 per unit from another supplier and rents its idle capacity for $5,000/month. How will the company’s monthly costs change?

Solution for Example

Step 1) Let’s start by calculating the cost to purchase. Zire will purchase the part for $8 and they need 10,000 parts per month. That results in a cost to purchase of $80,000 per month.

Step 2) Now we need to figure out what costs can be avoided. These are typically variable production costs like direct materials and direct labor. Fixed costs generally can’t be avoided, but it does say the company can now rent the idle space for $5,000 per month. So, our avoidable costs are $40,000 of direct materials, $30,000 of direct labor, and $5,000 of rent. That totals avoidable costs of $75,000.

Step 3) Now we just take the difference, and we can see that monthly costs will increase $5,000 since Zire decided to purchase the part from the supplier. If I were advising them, I would have told them it is cheaper to make the part!


Back To All Questions

You might also be interested in...

  • Three Reasons to Become an Accountant

    If you’re someone who is intrigued by numbers, enjoys problem-solving and wants to help others, then accounting might be the perfect career for you. While some people may be put off by its unalluring reputation, accounting is an excellent career choice that has many benefits. In this article, we look at three of the reasons...

  • Qualified Retirement Planning: Tax Advantages & Disadvantages

    Home Advantages and Disadvantages of Tax-Free and Deferred-Tax Retirement Plans What are “qualified retirement plans” and how can they be effective for tax planning? Well, there are plenty of tax savings advantages to individuals contributing to tax-free retirement accounts, as well as tax-deferred retirement accounts. However, this doesn’t necessarily mean that there are no disadvantages...

  • CPA Evolution Survival Guide

    Download Your eBook by selecting the download icon in the top right-hand corner