Ramon Corporation makes 18,000 units of part E44 each year. This part is used in one of the company's products. 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 and sell the part to the company for $23.30 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including 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. If the outside supplier's offer were accepted, only $5,000 of these allocated general overhead costs would be avoided. In addition, the space used to produce part E44 would be used to make more of one of the company's other products, generating an additional segment margin of $21,000 per year for that product. What would be the impact on the company's overall net operating income of buying part E44 from the outside supplier?
A)Net operating income would increase by $21,000 per year.
B)Net operating income would increase by $18,800 per year.
C)Net operating income would decrease by $123,000 per year.
D)Net operating income would decrease by $165,000 per year.

Question

Ramon Corporation makes 18,000 units of part E44 each year. This part is used in one of the company's products. 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 and sell the part to the company for $23.30 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including 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. If the outside supplier's offer were accepted, only $5,000 of these allocated general overhead costs would be avoided. In addition, the space used to produce part E44 would be used to make more of one of the company's other products, generating an additional segment margin of $21,000 per year for that product. What would be the impact on the company's overall net operating income of buying part E44 from the outside supplier?
A)Net operating income would increase by $21,000 per year. 
B)Net operating income would increase by $18,800 per year. 
C)Net operating income would decrease by $123,000 per year. 
D)Net operating income would decrease by $165,000 per year.

Quizplus · Accepted Answer

The relevant costs to consider in this decision are:

- Direct materials: $8.00 per unit 
- Direct labor: $7.50 per unit 
- Variable factory overhead: $2.50 per unit 
- Allocated general overhead: $12,000 per year / 18,000 units = $0.67 per unit 
- Supervisor's salary: $60,000 per year

If Ramon Corporation makes the part in-house, the total cost per unit is:

$8.00 + $7.50 + $2.50 + $0.67 = $18.67

The total cost of making 18,000 units is:

$18.67 * 18,000 = $336,060

If Ramon Corporation buys the part from the outside supplier, the cost per unit is $23.30. The total cost of buying 18,000 units is:

$23.30 * 18,000 = $419,400

By buying the part from the outside supplier, the following costs will be avoided:

- Direct labor: $7.50 per unit * 18,000 units = $135,000 
- Variable factory overhead: $2.50 per unit * 18,000 units = $45,000 
- Allocated general overhead: $0.67 per unit * 18,000 units = $12,060 
- Supervisor's salary: $60,000

Total avoided costs are:

$135,000 + $45,000 + $12,060 + $60,000 = $252,060

In addition, Ramon Corporation can use the space to make more of one of its other products, generating an additional segment margin of $21,000 per year.

The net impact on the company's overall net operating income is:

$21,000 (additional segment margin) - $167,340 (increase in costs from buying the part from outside supplier) = -$146,340

Therefore, the company's net operating income would decrease by $146,340 per year if it buys Part E44 from the outside supplier.

However, it is important to note that this decision may have other non-financial considerations as well, such as quality control and lead times.

Ramon Corporation Makes 18,000 Units of Part E44 Each Year