Lessons · Accounting · making a part or buying it
Make the part, or buy it
Compare the cost of making it with the cost of buying it, counting only what actually changes. The cost of making includes the variable cost of production and any fixed cost that would genuinely stop if you stopped making it, and excludes any that would not.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
In beta. This lesson was written for Hone and has not yet been checked by a qualified accountant. Practice material, not professional advice. What that means.
What it is for
It is the decision most often made wrongly from a standard cost card, because that card carries absorbed fixed overhead which does not disappear when production stops. Buying looks cheaper than it is, the part is outsourced, and the overhead simply reallocates itself onto everything else.
How to think about it
Build the make column from avoidable costs only. Build the buy column from the purchase price plus anything new it brings, such as freight or inspection. Then ask what the freed capacity would do, because if it can earn something, that belongs in the comparison too.
Worked example
Make: variable 14.00 a unit, 10,000 units = 140,000Avoidable in full.
Plus supervisor's salary 20,000, which ends if the line closesAvoidable fixed. It counts.
Absorbed factory rent, which continues regardlessNot avoidable. It does not count, whatever the cost card says.
Make = 160,000 against buy at 15.50 × 10,000 = 155,000. Buy, and save 5,000And the answer would have been the opposite if the rent had been let in.
Your turn
Variable 140,000 and avoidable fixed 20,000. Write the line for the relevant cost of making.
Make = 140,000 + = 160,000
Solve one, graded on the server
The trap
Using the full unit cost from the cost card. It contains absorbed fixed overhead that will not stop, and it is the single commonest reason a make-or-buy decision comes out backwards.