Knaack Corporation is presently making part R20 that is used in one of its products. A total of 18,000 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 produce and sell the part to the company for $27.70 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, none of which would be avoided if the part were purchased instead of produced internally.
-If management decides to buy part R20 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 $162,000 per year.
B)Net operating income would increase by $50,400 per year.
C)Net operating income would decline by $50,400 per year.
D)Net operating income would decline by $162,000 per year.

Question

Knaack Corporation is presently making part R20 that is used in one of its products. A total of 18,000 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 produce and sell the part to the company for $27.70 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, none of which would be avoided if the part were purchased instead of produced internally.
-If management decides to buy part R20 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 $162,000 per year. 
B)Net operating income would increase by $50,400 per year. 
C)Net operating income would decline by $50,400 per year. 
D)Net operating income would decline by $162,000 per year.

Quizplus · Accepted Answer

The relevant cost of producing part R20 is $54 per unit, while the outside supplier will provide it for $48 per unit. Therefore, if the company buys the part from the outside supplier, it will save $6 per unit. The company currently produces 14,000 units of this part per year, so the total annual saving will be $6 x 14,000 = $84,000. However, the company will incur additional fixed costs of $134,400 per year (i.e., $9.60 x 14,000) for the outsourcing arrangement. Hence, the net effect on the company's overall net operating income will be a decline of $84,000 - $134,400 = - $50,400 per year.

Knaack Corporation Is Presently Making Part R20 That Is Used