Kampmann Corporation is presently making part Z95 that is used in one of its products. A total of 5,000 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 and sell the part to the company for $24.10 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 Z95 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 decrease by $36,000 per year.
B)Net operating income would decrease by $34,000 per year.
C)Net operating income would increase by $34,000 per year.
D)Net operating income would increase by $36,000 per year.

Question

Kampmann Corporation is presently making part Z95 that is used in one of its products. A total of 5,000 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 and sell the part to the company for $24.10 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 Z95 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 decrease by $36,000 per year. 
B)Net operating income would decrease by $34,000 per year. 
C)Net operating income would increase by $34,000 per year. 
D)Net operating income would increase by $36,000 per year.

Quizplus · Accepted Answer

If the company decides to buy part Z95 from the outside supplier, the only costs that would be avoided are the supervisor's salary and the variable costs. The fixed costs, which are part of the allocated general overhead, would still be incurred.

Total variable cost per unit = Direct materials + Direct labor + Variable overhead
Total variable cost per unit = $8.60 + $5.70 + $3.10
Total variable cost per unit = $17.40

Total cost to produce 5,000 units = Total fixed costs + Total variable costs
Total cost to produce 5,000 units = ($70,000 + $130,500) + ($17.40 x 5,000)
Total cost to produce 5,000 units = $200,500

Total cost to buy 5,000 units from the outside supplier = 5,000 x $24.10
Total cost to buy 5,000 units from the outside supplier = $120,500

Annual impact on net operating income = Total cost to produce internally - Total cost to buy from outside supplier
Annual impact on net operating income = $200,500 - $120,500
Annual impact on net operating income = $80,000

Since the company's net operating income would decrease by $80,000 if they buy part Z95 from the outside supplier, the correct answer is A) Net operating income would decrease by $36,000 per year.

Kampmann Corporation Is Presently Making Part Z95 That Is Used