[lsutigers03]

NINJA Question –

A company is considering outsourcing one of the component parts for its product. The company currently makes 10,000 parts per month. Current costs are as follows:

Per Unit Total

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Direct materials $4 $40,000

Direct labor 3 30,000

Fixed plant facility cost 2 20,000

The company decides to purchase the part for $8 per unit from another supplier and rents its idle capacity for $5,000/month. How will the company’s monthly income before taxes change?

A. Decrease $15,000

B. Decrease $10,000

C. Increase $5,000

D. Increase $10,000

I though the answer would be Decrease $5,000 ($10,000 increase in costs and $5,000 income from renting the idle space)

Here is the answer. I feel stupid because I don’t understand why the answer is C.

The product should be produced if the incremental cost to produce the product, including any opportunity cost of idle facilities, is less than the purchase price.

Since the fixed plant charge will not change due to this decision, it is irrelevant and should not be considered. The direct materials and direct labor costs ($40,000 + $30,000 = $70,000) are relevant costs. These incremental costs total $70,000 per month to make the product, while they can buy the part for $80,000 per month, an increase in monthly costs of $10,000.

However, the rental income from renting the idle capacity of $5,000 reduces the monthly cost of purchasing the parts, for a net increase in monthly income before taxes of $5,000.

REG - 78
BEC - 74, 67, 69, 69, 70, 79
FAR - 76
AUD - 69, 69, 69, 74, 85

Licensed Louisiana CPA

“You never fail until you stop trying.”
― Albert Einstein

[M.O.D.]

You are right, the answer is wrong.

“These incremental costs total $70,000 per month to make the product, while they can buy the part for $80,000 per month, an increase in monthly costs of $10,000.”

So far so good.

“However, the rental income from renting the idle capacity of $5,000 reduces the monthly cost of purchasing the parts,”

So far so good.

“for a net increase in monthly income before taxes of $5,000.”

Should be for a DECREASE … of $5000.

BA Mathematics, UC Berkeley
Certificates in CPA and EA preparation, College of San Mateo
CMA I 420, II 470
FAR 91, AUD Feb 2015 (Gleim self-study)

[lsutigers03]

Ok thanks for the reply.

REG - 78
BEC - 74, 67, 69, 69, 70, 79
FAR - 76
AUD - 69, 69, 69, 74, 85

Licensed Louisiana CPA

“You never fail until you stop trying.”
― Albert Einstein

[Author]

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