Libbee Corporation is presently making part I50 that is used in one of its products. A total of 8,000 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 $24.50 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 I50 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 decline by $6,400 per year.
B) Net operating income would decline by $32,800 per year.
C) Net operating income would increase by $32,800 per year.
D) Net operating income would increase by $6,400 per year.

Question

Libbee Corporation is presently making part I50 that is used in one of its products. A total of 8,000 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 $24.50 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 I50 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 decline by $6,400 per year. 
B) Net operating income would decline by $32,800 per year. 
C) Net operating income would increase by $32,800 per year. 
D) Net operating income would increase by $6,400 per year.

Quizplus · Accepted Answer

The total cost of producing 8,000 units of part I50 internally is $195,000 ($60,000 + $20,000 + $100,000 + $15,000). If the company buys the part from the outside supplier for $24.50 each, the total cost would be $196,000 (8,000 units x $24.50). Therefore, the company would incur an additional cost of $1,000 ($196,000 - $195,000) by buying the part from the outside supplier.

Since none of the allocated general overhead would be avoided if the company buys the part from the outside supplier, the company's overall net operating income would decline by $1,000. However, the supervisor's salary and all of the variable costs, including direct labor, can be avoided, resulting in a cost savings of $31,800 ($20,000 + $15,000 + $8,800). Therefore, the net impact on the company's overall net operating income would be a decline of $32,800 ($1,000 - $31,800) per year.

Libbee Corporation Is Presently Making Part I50 That Is Used