ExpertMedium1 markMultiple Choice
CPA · Question 16 · Area I: Business Analysis
A company currently manufactures a component with the following unit costs: Direct Materials $10, Direct Labor $8, Variable Overhead $4, Fixed Overhead $6. Total cost is $28. A supplier offers to sell the component for $25. If the company buys the component, $4 of the fixed overhead can be avoided. What is the financial advantage or disadvantage of buying?
A company currently manufactures a component with the following unit costs: Direct Materials $10, Direct Labor $8, Variable Overhead $4, Fixed Overhead $6. Total cost is $28. A supplier offers to sell the component for $25. If the company buys the component, $4 of the fixed overhead can be avoided. What is the financial advantage or disadvantage of buying?
Answer options:
A.
$3 advantage per unit
B.
$1 disadvantage per unit
C.
$3 disadvantage per unit
D.
$1 advantage per unit
How to approach this question
Identify relevant costs. Relevant costs to make = Variable Costs + Avoidable Fixed Costs. Compare this sum to the Purchase Price.
Full Answer
D.$1 advantage per unit✓ Correct
D
Relevant Cost to Make:<br/>DM: $10<br/>DL: $8<br/>VOH: $4<br/>Avoidable Fixed: $4<br/>Total Relevant Make Cost: $26<br/><br/>Cost to Buy: $25<br/><br/>Savings per unit = $26 - $25 = $1.
Common mistakes
Including unavoidable fixed costs in the 'Make' cost; ignoring avoidable fixed costs.
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