Foster Industries manufactures 20,000 components per year.The manufacturing cost of the components was determined as follows: $\begin{array}{lr}
\text { Direct materials } & \$ 150,000 \
\text { Direct labour } & 240,000 \
\text { Variable manufacturing overhead } & 90,000 \
\text { Fixed manufacturing overhead } & 120,000 \
\text { Total } & \$ 600,000
\end{array}$
An outside supplier has offered to sell the component for $25.50.
What is the effect on income if Foster Industries purchases the component from the outside supplier?

Question

Foster Industries manufactures 20,000 components per year.The manufacturing cost of the components was determined as follows: $\begin{array}{lr}
\text { Direct materials } & \$ 150,000 \
\text { Direct labour } & 240,000 \
\text { Variable manufacturing overhead } & 90,000 \
\text { Fixed manufacturing overhead } & 120,000 \
\text { Total } & \$ 600,000
\end{array}$ 
An outside supplier has offered to sell the component for $25.50.
What is the effect on income if Foster Industries purchases the component from the outside supplier?

Quizplus · Accepted Answer

The total cost to manufacture is $600,000 for 20,000 components, which is $30 per component. Buying externally at $25.50 per component for 20,000 components would cost $510,000, saving $90,000. However, the fixed manufacturing overhead of $120,000 would still be incurred whether they make or buy, making the real saving only $90,000 - $120,000 = -$30,000, thus decreasing income by $30,000.

Foster Industries Manufactures 20,000 Components Per Year An Outside Supplier Has Offered to Sell the Component for the Components