North Company produces a small part that it uses in the production of its Product H. The company’s unit product

cost for the part, based on a production of 100,000 parts per year, is as follows:

………………………………………….Per part ………………..Total

Direct Materials………………………. $7.00………..$700,000

Direct Labor …………………………….6.00…………$600,000

Variable Manufacturing Overhead 2.00………..$200,000

Plus:

Fixed manufacturing Overhead, (Traceable or avoidable) $400,000 TOTAL, equal to $4 per unit

Fixed manufacturing Overhead,( Common—not traceable to any product. Will stay even if no product is manufactured) allocated on basis of labor-hours 5.00)     $500,000 Total

Unit Product Cost……………………… $24.00 (7+ 6+ 2, variable of $15. Plus Fixed  4+ 5=9, total)

An outside supplier has offered to supply parts to the North Company for only $21.25 per part.(it appears to the President of the company that he could save $2.75 per unit.

100 percent of the traceable or avoidable fixed manufacturing cost is supervisor salaries and other costs that can be ELIMINATED if the parts are purchased. The decision to buy the parts from the outside supplier would have no effect on the common fixed costs of the company, and the space being used to produce the parts would otherwise be idle. Ignore the impact of income taxes in your calculation.

How much would profits increase or decrease as a result of purchasing the parts from the

outside supplier rather than making them inside the company?

 

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