Question

Green Company produces 1,000 parts per year, which are used in the assembly of one of its products. The unit product cost of these parts is:

Variable Manufacturing Cost	$12
Fixed Manufacturing Cost	$9
Unit Product Cost	$21

The part can be purchased from an outside supplier for $20 per unit. If the part is purchased from the outside supplier, two-thirds of the fixed manufacturing costs can be eliminated. What will be the annual impact on the company's operating income of buying the part from the outside supplier? (Do not round intermediate calculations.)

Multiple Choice

• $1,000 increase.

• $1,000 decrease.

• $2,000 decrease.

• $5,000 increase.

Answer 1

Correct answer------------$2,000 decrease.

Working

Differential Analysis
	Make	Buy
Variable manufacturing cost (1000 x 12)	$       12,000.00
Avoidable Fixed overhead (1000 x 6*)	$          6,000.00
Purchase price		$         20,000.00
Total relevant Cost	$       18,000.00	$         20,000.00

*6 per unit of fixed cost is avoidable. Only avoidable fixed cost is relevant cost.

Total Cost of Buying	$             20,000
Total Cost of manufacturing	$             18,000
Financial Disadvantage of buying	$ ( 2,000)