At Outsourcing Corporation they are presently making part ABC88354 that is used

Question

At Outsourcing Corporation they are presently making part ABC88354 that is used in one of its products. A total of 9,600 units of this part are produced and used every year. The company's Accounting Department reports the following costs of producing the part at this level of activity: Per Unit Direct materials $5.80 Direct labor $3.20 Variable manufacturing overhead $4.50 Supervisor's salary $2.60 Depreciation of special equipment $6.90 Allocated general overhead $3.20 An outside supplier has offered to make and sell the part to the company for $18.00 each. If this offer is accepted, the supervisor's salary and all of the variable costs can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company, none of which would be avoided if the part were purchased instead of produced internally. If management decides to buy part ABC88354 from the outside supplier rather than to continue making the part, what would be the annual impact on the company's overall net operating income?

A)Net operating income would increase by $78,720 per year.

B)Net operating income would decline by $78,720 per year.

C)Net operating income would increase by $18,240 per year.

D)Net operating income would decline by $18,240 per year.

Explanation / Answer

NOTE:

FOR* = *Mark items has not been included while calculating operating income and loss. For calculating operating income fixed cost are not taken into account as fixed is the cost which in incurred irrespective of selling of product. As depreciation on equipment is a fixed cost and allocated general overheads are also part of fixed cost, hence not been taken.

STATEMENT SHOWING OPERATING PROFIT/LOSS OF THE YEAR PARTICULARS PER UNIT VALUE IN $ Units 9600 IN $ SELLING PRICE (9600*$18) $    18.00 $ 172,800.00 DIRECT MATERIAL $       5.80 DIRECT LABOUR $       3.20 MANUFACTURING OVERHEAD $       4.50 VARIABLE OVERHEAD (A) $    13.50 SUPERVISOR SALARY (B) $       2.60 TOTAL COST (A+B) $    16.10 $ 154,560.00 DEPRICIATION* $       6.90 - ALLOCATED GENERAL OVERHEAD* $       3.20 - NET OPERATING INCOME/LOSS                                         (SELLING PRICE -TOTAL COST) $    18,240.00

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