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Decision-making techniquesRelevant CostingMake or BuyExpected ValuesRisk and Uncertainty

ACCA · Question 31 · Decision-making techniques

Section C

Scenario: TransGlobal Logistics

TransGlobal Logistics operates a large fleet of cross-border freight trucks. Currently, they maintain their fleet in-house. The annual costs for the in-house maintenance department are:

  • Mechanics' salaries (fixed contracts): $400,000
  • Parts and materials (variable): $1,200 per truck serviced
  • Apportioned head office overheads: $150,000
  • Depreciation of maintenance equipment: $80,000

A third-party company, FleetCare, has offered to take over the maintenance on a 'pay-as-you-go' basis, charging $2,500 per truck serviced.

If TransGlobal outsources to FleetCare, the mechanics will be made redundant, incurring a one-off total redundancy cost of $100,000. The maintenance equipment could be sold immediately for $50,000. The head office overheads will not change.

The number of trucks requiring service next year is uncertain due to fluctuating trade tariffs. The probabilities are:

  • Low demand: 200 trucks (Probability 0.3)
  • Medium demand: 350 trucks (Probability 0.5)
  • High demand: 500 trucks (Probability 0.2)

Required:

(a) Calculate the Expected Value (EV) of the number of trucks requiring service next year. (3 marks)

(b) Using relevant costing principles and the Expected Value calculated in part (a), determine whether TransGlobal should continue to maintain the trucks in-house or outsource to FleetCare for the next year. Show all calculations clearly. (12 marks)

(c) Discuss TWO limitations of using Expected Values as the primary basis for this decision. (5 marks)

How to approach this question

Part (a): Multiply each outcome by its probability and sum them. Part (b): Identify which costs are relevant (future, incremental cash flows). Ignore depreciation and apportioned overheads. Include opportunity costs (lost sale of equipment) and one-off costs (redundancy). Compare total relevant costs for both options using the EV volume. Part (c): Think about why averages are dangerous for one-off decisions and how they hide risk.

Full Answer

This question tests the application of relevant costing principles to a make-or-buy decision under uncertainty. The key is filtering out irrelevant costs (sunk costs, non-cash items like depreciation, and unavoidable apportioned overheads) and correctly handling opportunity costs (the foregone sale of equipment) and one-off incremental costs (redundancies). Expected values provide a mathematical average to base the volume on, but their limitation is that they hide the variance and risk of a one-off decision.

Common mistakes

Including depreciation as a relevant cost. Forgetting to include the $50k opportunity cost of the equipment in the 'Make' option. Applying the redundancy cost to the 'Make' option instead of the 'Buy' option.
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