Cheong Automobiles Company fabricates automobiles.Each vehicle includes one wiring harness,which is currently made in-house.Details of the harness fabrication are as follows: $$\begin{array} { | l | r | l | }
\hline \text { Volume } & 1,200 & \text { units per month } \
\hline \text { Variable cost per unit } & \$ 10.50 & \text { per unit } \
\hline \text { Fixed costs } & \$ 15,000 & \text { per month } \
\hline
\end{array}$$ An Indonesian factory has offered to supply Cheong Company with ready-made units for a cost of $15 for each harness.Assume that Cheong's fixed costs are unavoidable and that Cheong will not be able to use the excess capacity in any profitable manner.If Cheong decides to outsource,monthly operating income will ________.

Question

Cheong Automobiles Company fabricates automobiles.Each vehicle includes one wiring harness,which is currently made in-house.Details of the harness fabrication are as follows: $$\begin{array} { | l | r | l | } 
\hline \text { Volume } & 1,200 & \text { units per month } \
\hline \text { Variable cost per unit } & \$ 10.50 & \text { per unit } \
\hline \text { Fixed costs } & \$ 15,000 & \text { per month } \
\hline
\end{array}$$ An Indonesian factory has offered to supply Cheong Company with ready-made units for a cost of $15 for each harness.Assume that Cheong's fixed costs are unavoidable and that Cheong will not be able to use the excess capacity in any profitable manner.If Cheong decides to outsource,monthly operating income will ________.

Quizplus · Accepted Answer

The current total cost of in-house production is the sum of variable costs and fixed costs. Variable costs are $10.50 per unit for 1,200 units, which equals $12,600. Fixed costs are $15,000. So, the total current cost is $12,600 + $15,000 = $27,600. If Cheong outsources, the cost will be $15 per unit for 1,200 units, which equals $18,000. The difference in costs is $27,600 (current) - $18,000 (outsourced) = $9,600. However, since the fixed costs of $15,000 are unavoidable, they should not be considered in the savings calculation, leading to an incorrect interpretation in the explanation. The correct calculation for the change in costs solely based on variable costs and the cost of outsourcing gives a decrease in monthly operating income, not an increase, due to the higher cost per unit when outsourcing.

Cheong Automobiles Company Fabricates Automobiles An Indonesian Factory Has Offered to Supply Cheong Company with Is