Question

Charleston Inc. manufactures 40,000 components per year. The manufacturing cost of the components total $190,000 and are comprised of direct materials, $90,000 direct labor, $50,000 variable manufacturing overhead, $20,000 and fixed manufacturing overhead $30,000. If Charleston purchases the component from an outside supplier for $4.25 per unit, how will the company's operating profit be impacted? Please show step by step solution.

a. none of these
b. $10,000 decerase
c. $30,000 increase
d. $10,000 increase
e. $30,000 decrease

Answer 1

a. None of these

Step-by-step explanation:

As we can tell from the statement, Charleston Inc. only manufacturates this type of component, so if it stops producing it by buying it to an outside supplier, the factory will close and it will only became a trader of the component.

Given that, we have to compare the total production cost of the components (including fixed overhead) with the cost of buying them to an outside supplier:

Total production cost: $ 190.000

Total cost of outsourced components: $/u 4,25 * 40,000 Units= $ 170.000

So, if the cost decreases ( 170,000- 190,000= -20,000) in $ 20,000, the profit will increase in $ 20,000 which was not given in the possible choices. That´s why I chose a), but...

If, the factory doesn't close, the fixed overhead costs will still exist, so we only have to compare the variable costs (190,000-30,000= $ 160,000).

Variable original production cost = $160,000 vs Outsourced cost = 170,000 => the cost increase $ 10,000, so the profit decreases $10,000

But it has no sense to maintain a factory when there is no possible production so, that's why I didn't choose option b)