Question

11. Barker Inc. manufactures 20,000 components per year. The manufacturing cost of the components is: Direct materials Direct labor Inspecting products Providing power Providing supervision Setting up equipment Moving materials Total $ 150,000 $ 240,000 $ 160,000 $ 130,000 $ 140,000 $ 260,000 $ 120,000 $1,200,000 If the component is not produced internally, then inspection of products and provision of power costs will only be 20% of the current costs, moving materials costs and setting up equipment costs will only be 40% of the current costs, and supervision costs will be only 30% of the current cost. An outside supplier has offered to sell the component to Barker for $65.30 per component. If Barker purchases the component from the outside supplier, then what will be the effect on Barker's operating income? a) $664,000 decrease b) $358,000 decrease c) $296,000 increase d) $25,000 increase e) None of the above

If you could provide an explanation as to why we use some variables and not others that would be super helpful. Thanks!

Answer 1

	Cost of making	Cost of buying	Increase/Decrease in income
Direct material	150,000	0	150,000
Direct labor	240,000	0	240,000
Inspecting products	160,000	160,000 x 20% = 32,000	128,000
Providing power	130,000	130,000 x 20% = 26,000	104,000
Providing supervision	140,000	140,000 x 30% = 42,000	98,000
Setting up equipment	260,000	260,000 x 40% = 104,000	156,000
Moving materials	120,000	120,000 x 40% = 48,000	72,000
Outside supplier's price	0	20,000 x 65.30 = 1,306,000	- 1,306,000
	$1,200,000	1,558,000	- 358,000

If component is purchased from outside supplier, operating income would decrease by $358,000

Correct option is (b)

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