Question

AlphaBrona Industries manufactures 50,000 components per year. The manufacturing cost of the components was determined as follows:

Direct materials $ 80,000
Direct labor 100,000
Variable overhead 30,000
Fixed overhead 60,000
Total $270,000

An outside supplier has offered to sell the component for $10. Fixed costs will remain the same if the component is purchased from an outside supplier. What is the effect on income if AlphaBrona Industries purchases the component from the outside supplier?

a.$290,000 decrease
b.$45,000 decrease
c.$290,000 increase
d.$45,000 increase

Answer 1

Answer:

Option (a) is correct.

Explanation:

Manufacturing cost:

= Direct materials + Direct labor + Variable overhead + Fixed overhead

= $80,000 + $100,000 + $30,000 + $60,000

= $270,000

Purchase from outside:

= Fixed overhead + Purchase price

= $60,000 + (50,000 × $10)

= $60,000 + $500,000

= $560,000

Effect on income = Purchase from outside - Manufacturing cost

                            = $560,000 - $270,000

                            = $290,000

Therefore, the above calculations shows that income will decrease by $290,000.