Kleffman Corporation is presently making part X31 that is used in one of its products. A total of 2,000 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 $23.40 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 $1,000 of these allocated general overhead costs would be avoided.
-In addition to the facts given above, assume that the space used to produce part X31 could be used to make more of one of the company's other products, generating an additional segment margin of $23,000 per year for that product. What would be the impact on the company's overall net operating income of buying part X31 from the outside supplier and using the freed space to make more of the other product?
A) Net operating income would increase by $17,400 per year.
B) Net operating income would increase by $21,200 per year.
C) Net operating income would decline by $28,600 per year.
D) Net operating income would increase by $23,000 per year.

Question

Kleffman Corporation is presently making part X31 that is used in one of its products. A total of 2,000 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 $23.40 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 $1,000 of these allocated general overhead costs would be avoided.
-In addition to the facts given above, assume that the space used to produce part X31 could be used to make more of one of the company's other products, generating an additional segment margin of $23,000 per year for that product. What would be the impact on the company's overall net operating income of buying part X31 from the outside supplier and using the freed space to make more of the other product?
A) Net operating income would increase by $17,400 per year. 
B) Net operating income would increase by $21,200 per year. 
C) Net operating income would decline by $28,600 per year. 
D) Net operating income would increase by $23,000 per year.

Quizplus · Accepted Answer

If Kleffman Corporation decides to buy part X31 from the outside supplier, it will save the costs of direct materials, direct labor, supervisor's salary and other variable costs, which add up to $35.50 per unit. Therefore, total cost savings per year would be $71,000 (2,000 units × $35.50 per unit). However, the company would still have to incur $61,000 for allocated general overhead costs (2,000 units × $30.50 per unit - $1,000 avoided overhead costs if outsourced).

The space that can be freed up would generate an additional segment margin of $23,000 per year for one of the company's other products. Therefore, the net impact on overall net operating income would be an increase of $33,000 per year ($71,000 cost savings - $61,000 allocated general overhead costs + $23,000 additional segment margin).

Hence, the option B is the correct answer.

Kleffman Corporation Is Presently Making Part X31 That Is Used