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: $\begin{array}{l}
\text { Variable Manufacturing Cost } &\$ 12 \
\text { Fixed Manufacturing Cost } &\$ 9\
\text { Unit Product Cost } &\$ 21
\end{array}$
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?

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: $\begin{array}{l}
\text { Variable Manufacturing Cost } &\$ 12 \
\text { Fixed Manufacturing Cost } &\$ 9\
\text { Unit Product Cost } &\$ 21
\end{array}$ 
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?

Quizplus · Accepted Answer

If the company continues to produce the parts itself, the total unit cost of each part would be $21. On the other hand, if the company purchases the parts from the outside supplier, the unit cost of each part would be $20. Since the fixed cost is eliminated by 2/3, the new fixed cost per part produced would be $3. Therefore, the unit cost per product drops down to $20+$3=$23.

By buying the parts, the company saves $21-$23=-$2 per part. That means the company will save $2,000 (1,000 x $2) in total by purchasing the parts instead of producing them itself. Therefore, the operating income will increase by $2,000. However, the question asks for the annual impact on operating income, so the answer will be $2,000/1= $2,000 decrease.

Green Company Produces 1,000 Parts Per Year,which Are Used in the Assembly