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Mallory Company manufactures widgets. Bowden Company has approached Mallory with a proposal to sell the company widgets at a price of $82,000 for 100,000 units. Mallory is currently making these components in its own factory. The following costs are associated with this part of the process when 100,000 units are produced: Direct material $ 31,000 Direct labor 29,000 Manufacturing overhead 40,000 Total $100,000 The manufacturing overhead consists of $16,000 of costs that will be eliminated if the components are no longer produced by Mallory. From Mallory's point of view, how much is the incremental cost or savings if the widgets are bought instead of made? Select one: a. $18,000 incremental savings b. $6,000 incremental cost c. $2,000 incremental savings d. $18,000 incremental cost

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Answer:

$6,000 incremental cost

Explanation:

Manufacturing the widgets in-house would be a more cost effective method than buying from Bowden Company.

Direct Costs relating to in-house manufacturing (of 100,000 units) are as follows:

Direct material = $31,000

Direct labour = $29,000

Manufacturing overhead directly related to the manufacture of the widgets: $16,000.

Therefore, total direct costs = $76,000.

Only the portion of manufacturing overhead directly affected by the widget production needs to be account for. This is because manufacturing overhead will be incurred irrespective of whether Mallory Company produces the widget or not. Therefore, manufacturing overhead is not an incremental cost incurred by the widget production, except for the portion directly affected.

Accordingly, producing in-house ($76,000 direct cost) is more cost effective that buying from Bowden Company ($82,000) by $6,000.

The incremental cost if the widgets are bought instead of made is therefore $6,000.

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