Harris Company uses 5,000 units of part AA1 each year. The cost of manufacturing one unit of part AA1 at this volume is as follows: $\begin{array}{lr}
\text { Direct materials } & £ 10.00 \
\text { Direct labour } & 14.00 \
\text { Variable overhead } & 6.00 \
\text { Fixed overhead } & 4.00 \
\text { Total } & £ 34.00
\end{array}$ An outside supplier has offered to sell Harris Company unlimited quantities of part AA1 at a unit cost of £31.00. If Harris Company accepts this offer, it can eliminate 50 per cent of the fixed costs assigned to part AA1. Furthermore, the space devoted to the manufacture of part AA1 would be rented to another company for £24,000 per year. If Harris Company accepts the offer of the outside supplier, annual profits will
A)increase by £29,000.
B)increase by £14,500.
C)increase by £22,000.
D)increase by £2,500.

Question

Quizplus · Accepted Answer

The current cost of manufacturing one unit of part AA1 is £34.00, including £4.00 of fixed costs. If Harris Company accepts the offer, they can buy the part for £31.00, saving £3.00 per unit. The annual savings from purchasing the part would be £3.00 * 5,000 units = £15,000. Additionally, by eliminating 50% of the fixed costs (£4.00 * 50% = £2.00 per unit), the company saves an additional £2.00 * 5,000 units = £10,000 annually. Renting out the space would add another £24,000 to the annual profits. Therefore, the total increase in annual profits would be £15,000 (savings from buying the part) + £10,000 (savings from reduced fixed costs) + £24,000 (rental income) = £49,000. However, this calculation overlooks the fact that the £49,000 includes the £24,000 rental income as a new addition to profits, not as a part of the savings from manufacturing costs. The correct calculation for the increase in profits due to cost savings alone (excluding the rental income, which was mistakenly added to the savings) is £15,000 + £10,000 = £25,000. When considering the rental income correctly as an additional profit rather than a saving, the total increase in profits should be recalculated to accurately reflect the impact of all factors, including the rental income, savings from buying parts instead of manufacturing, and reduced fixed costs.

Harris Company Uses 5,000 Units of Part AA1 Each Year