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

Current Operation (purchase of cookies) - $0.60

Alternative - $0.2 materials

$0.15 direct labor

$0.45 without increasing capacity of which $0.3 is fixed - meaning it would still be incurred at current capacity

                        Mel's Meals Evaluation of Alternatives

                                       Purchase                                Produce

                                            $                                              $

Cost to Buy                        0.6                                             -

Materials                               -                                             0.2

Direct Labor                         -                                             0.15

Overhead (Variable)            -                                             0.15

Total Cost                            0.6                                          0.5

Decision: Mel should not continue buying them as she would be saving $0.1 for every lunch meal.

Since there would not be an increase in the total fixed overhead if Mel's makes the cookies in-house, then the $0.3 fixed overhead is not significant in calculating the cost of producing.

Explanation:

The differential cost in this instance is $0.1 as Mel's saves that for every cookie made which multiplied by the number included in the box and by the total box prepared and sold gives = 0.1 * 2 * 10000 = $2,000 saved for making

The total cost of Mel Buying the cookies is $7,500, the total cost of Mel making the cookies is $11,500, the differential cost is $4,000, I will advise Mel to continue buying the cookies

Explanation:

Comparative cost statements for two alternatives

Mel Make. Mel Buy

$ $

Direct materials (0.20 × 10,000) 2,000. -

Direct Labour ($0.15 × 10,000) 1,500. 1,500

Variable overhead ($0.15 × 10,000) 1,500. 1,500

Fixed overhead ($0.30 × 10,000) 3,000. -

Cost price. 8,000. 6,000

Total Cost. 16,000. 9,000

The fixed overhead apportioned to the cookies will still be incurred whether or not Mel purchase the cookies from outside supplier. Fixed overhead and direct labour are therefore irrelevant in deciding which alternative to choose.if the cookies were purchased from outside supplier. Since it will be different for each alternative, we can compute the cost statement for the two alternative using only relevant cost as follows

Mel Make. Mel Buy

$ $

Direct materials. 2,000. -

Variable overhead. 1,500. 1,500

Cost price. 8,000. 6,000

Total Cost. 11,500. 7,500

The Differential cost is (11,500 - 7,500) = 4,000

Based on the cost statement I will advise Mel to continue buying the cookies