Part N29 is used by Farman Corporation to make one of its products. A total of 11,000 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: An outside supplier has offered to make the part and sell it to the company for $21.20 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including the direct labor, 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. In addition, the space used to make part N29 could be used to make more of one of the company's other products, generating an additional segment margin of $29,000 per year for that product. What would be the impact on the company's overall net operating income of buying part N29 from the outside supplier?
A)Net operating income would decline by $38,900 per year.
B)Net operating income would increase by $29,000 per year.
C)Net operating income would decline by $32,600 per year.
D)Net operating income would increase by $19,100 per year.

Question

Part N29 is used by Farman Corporation to make one of its products. A total of 11,000 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:  An outside supplier has offered to make the part and sell it to the company for $21.20 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including the direct labor, 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. In addition, the space used to make part N29 could be used to make more of one of the company's other products, generating an additional segment margin of $29,000 per year for that product. What would be the impact on the company's overall net operating income of buying part N29 from the outside supplier?
A)Net operating income would decline by $38,900 per year. 
B)Net operating income would increase by $29,000 per year. 
C)Net operating income would decline by $32,600 per year. 
D)Net operating income would increase by $19,100 per year.

Quizplus · Accepted Answer

If the company decides to buy part N29 from the outside supplier, it will avoid the supervisor's salary and all variable costs, resulting in total cost savings of:

$55,000 + $110,000 + $22,000 + $66,000 = $253,000 per year

However, the allocated general overhead of $67,400 would continue to be incurred, as none of these costs would be avoided if the company purchases the part from the outside supplier.

In addition, the company would lose the contribution margin of $38,900 (11,000 units x $3.53 per unit) that it currently earns from producing the part internally.

Therefore, the net impact on the company's overall net operating income would be:

$253,000 - $67,400 - $38,900 = $146,700

This represents a decline in net operating income of $32,600 ($146,700 - $179,300), compared to the current situation where the company produces the part internally.

Part N29 Is Used by Farman Corporation to Make One