Polly is evaluated based on the reported profits of her product line. For her average product, materials cost 20% of total costs. Labor and allocated overhead have equal shares of the remainder; the equivalence obtains because Polly's firm allocates overhead at the rate of 100% of labor cost.
Polly is considering a proposal to outsource manufacture of a particular product, paying $90,000 per year to the contractor. For this product, total annual direct costs (that is, the costs of materials and labor only) are $60,000. Based on conversations with her accounts manager, Polly believes that the total overhead cost for the firm would not change regardless of her decision about whether to outsource.
Required:
a. Calculate the change in the firm's profit if Polly outsources the product.
b. Calculate the change in the reported profit for Polly's products if she outsources the product.
c. Comment on the assertion that "allocations make fixed costs appear to be variable costs."