Fornelli, Inc. can produce 100 units of a component part with the following costs: $$\begin{array} { l r }
\text { Direct Materials } & \$ 15,000 \
\text { Direct Labor } & 6,500 \
\text { Variable Overhead } & 16,000 \
\text { Fixed Overhead } & 11,000
\end{array}$$ If Fornelli, Inc. can purchase the units externally for $40,000, by what amount will its total costs change?
A) An increase of $40,000
B) An increase of $2,500
C) An increase of $8,500
D) A decrease of $11,000

Question

Fornelli, Inc. can produce 100 units of a component part with the following costs: $$\begin{array} { l r } 
\text { Direct Materials } & \$ 15,000 \
\text { Direct Labor } & 6,500 \
\text { Variable Overhead } & 16,000 \
\text { Fixed Overhead } & 11,000
\end{array}$$ If Fornelli, Inc. can purchase the units externally for $40,000, by what amount will its total costs change?
A) An increase of $40,000
B) An increase of $2,500
C) An increase of $8,500
D) A decrease of $11,000

Quizplus · Accepted Answer

The total cost of producing the units internally is $15,000 (Direct Materials) + $6,500 (Direct Labor) + $16,000 (Variable Overhead) + $11,000 (Fixed Overhead) = $48,500. Purchasing externally for $40,000 instead of producing internally would decrease total costs by $8,500 ($48,500 - $40,000). However, the fixed overhead of $11,000 would still be incurred whether the units are produced internally or purchased externally. Therefore, the net change in total costs is a decrease of $8,500 less the fixed overhead that would still be incurred, resulting in an actual increase in total costs of $2,500.

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