CM Manufacturing has provided the following unit costs pertaining to a component they manufacture and use in the production of one of their main products: $$\begin{array} { | l | r | }
\hline \text { Direct materials } & \$ 420 \
\hline \text { Direct labor (variable) } & 110 \
\hline \text { Variable manufacturing overhead } & 90 \
\hline \text { Fixed manufacturing overhead } & 35 \
\hline
\end{array}$$ A supplier has offered to provide the component to CM manufacturing for $630 per unit. If CM Manufacturing acquire the component from the supplier, they could use the released facilities to manufacture a product which would generate contribution margin of $20,000 annually. Assuming that CM Manufacturing needs 3,000 components annually and the fixed manufacturing overhead is unavoidable, what would be the impact on operating income if the company outsources?

Question

CM Manufacturing has provided the following unit costs pertaining to a component they manufacture and use in the production of one of their main products: $$\begin{array} { | l | r | } 
\hline \text { Direct materials } & \$ 420 \
\hline \text { Direct labor (variable) } & 110 \
\hline \text { Variable manufacturing overhead } & 90 \
\hline \text { Fixed manufacturing overhead } & 35 \
\hline
\end{array}$$ A supplier has offered to provide the component to CM manufacturing for $630 per unit. If CM Manufacturing acquire the component from the supplier, they could use the released facilities to manufacture a product which would generate contribution margin of $20,000 annually. Assuming that CM Manufacturing needs 3,000 components annually and the fixed manufacturing overhead is unavoidable, what would be the impact on operating income if the company outsources?

Quizplus · Accepted Answer

If CM Manufacturing outsources the component, they will save the following costs:Direct materials: $420 x 3,000 = $1,260,000Direct labor: $110 x 3,000 = $330,000Variable manufacturing overhead: $90 x 3,000 = $270,000Total savings: $1,260,000 + $330,000 + $270,000 = $1,860,000However, they will incur the following additional costs:Purchased components: $630 x 3,000 = $1,890,000Therefore, the net impact on operating income will be a decrease of $1,890,000 - $1,860,000 = $30,000.However, CM Manufacturing will also generate an additional $20,000 in contribution margin from the product they can manufacture with the released facilities. Therefore, the overall impact on operating income will be a decrease of $30,000 - $20,000 = $10,000.

CM Manufacturing Has Provided the Following Unit Costs Pertaining to a Component