Answer the following question(s)using the information below.Konrade's Engine Company manufactures part TE456 used in several of its engine models.Monthly production costs for 1,000 units are as follows:
It is estimated that 10% of the fixed overhead costs assigned to TE456 will no longer be incurred if the company purchases TE456 from the outside supplier.Konrade's Engine Company has the option of purchasing the part from an outside supplier at $85 per unit.
-If Konrade's Engine Company purchases 1,000 TE456 parts from the outside supplier per month, then its monthly operating income will
A)increase by $13,000.
B)increase by $15,000.
C)decrease by $5,000.
D)decrease by $3,000.
E)decrease by $35,000.

Question

Answer the following question(s)using the information below.Konrade's Engine Company manufactures part TE456 used in several of its engine models.Monthly production costs for 1,000 units are as follows:
  It is estimated that 10% of the fixed overhead costs assigned to TE456 will no longer be incurred if the company purchases TE456 from the outside supplier.Konrade's Engine Company has the option of purchasing the part from an outside supplier at $85 per unit.
-If Konrade's Engine Company purchases 1,000 TE456 parts from the outside supplier per month, then its monthly operating income will
A)increase by $13,000. 
B)increase by $15,000. 
C)decrease by $5,000. 
D)decrease by $3,000. 
E)decrease by $35,000.

Quizplus · Accepted Answer

Current monthly production costs for 1,000 units = $30,000 variable costs + $60,000 fixed costs = $90,000

If the company purchases TE456 from an outside supplier, the variable costs will remain the same, but only 90% of the fixed overhead costs will be incurred. That means the fixed costs will decrease by 10% x $60,000 = $6,000.

Total cost per unit if the company purchases TE456 from the outside supplier = $30 variable costs + ($54 fixed costs / 1,000 units) = $84 per unit

Total cost of 1,000 units = 1,000 x $84 = $84,000

Savings from purchasing TE456 from the outside supplier = $90,000 - $84,000 = $6,000

However, the company will have to pay $85 per unit to purchase TE456 from the outside supplier, which amounts to $85,000 for 1,000 units.

Operating income if the company purchases 1,000 units from the outside supplier = $6,000 - $85,000 = -$79,000

Therefore, the company's monthly operating income will decrease by $3,000 if it purchases 1,000 TE456 parts from the outside supplier. The answer is D.

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