January 10th, 2018
How Make-or-Buy Decisions are made in a Company and Their Importance
One of the functions of accounting is to provide information to various stakeholders through external reporting. However accounting, especially cost accounting function, is also involved in providing internal reports that support decisions at different levels of the organization chart. Some of these decisions involve short-term business decisions where the time value of money is irrelevant and others involve capital investment decisions where the devaluation of money with time is a critical consideration (Bamber, Braun & Harrison, 2007). It is in the short-term business decisions that the aspect of incremental analysis has found its increasing use. Short-term decisions include special order decisions such as accepting additional business, make or buy decisions, halting manufacture of a particular product, selling or processing products further, and allocating limited resources among competing uses (Bamber, Braun & Harrison, 2007).
Make-or-buy decisions concern the selection of the most effective alternative between outsourcing part of the process to third parties and performing such processes in-house. While some entities might find it more economical to control the entire process from the primary input to the ultimate finished product; others might find it more beneficial if some of the intermediate products are outsourced from other entities (Platts, Probert, & Canez, 2002). This paper evaluates a case for make-or-buy decision to recommend whether the company should outsource some of its processes or control the entire process. The analysis relates to a milk processing plant – luscious creamery – that buys milk from farmers, processes it into various fresh and fermented products and then packages these into 500ml containers for distribution to wholesalers and retailers. The company is evaluating whether to manufacture the packaging cartons in-house or outsource the process to a different firm that specializes in the production of packaging products for various needs. Any choice taken implies that the entity will forego the alternative option and thus it cannot partially manufacture the packages while outsourcing the production of others. To make the decision the financial manager has requested the cost accountant to analyze the two options to advise on the alternative that would minimize the costs thus increase the profit margin for the entity. Go to part 2 here.