15. Part A42 is used by Elgin Corporation to make one of its products. A total o

Question

15. Part A42 is used by Elgin Corporation to make one of its products. A total of 16,000 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: Per Unit ....$7.50 Direct labor Variable manufacturing overhead. Supervisor's salary.... Depreciation of special equipment. $8.00 Allocated general overheadS5.30 $8.90 $5.50 $5.60 : An outside supplier has offered to make the part and sell it to the company for $30.40 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including the 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. In addition, the space used to make part A42 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 A42 from the outside supplier? A. Net operating income would decrease by $143,400 per year. B. Net operating income would increase by $23,000 per year. C. Net operating income would decrease by $189,400 per year. D. Net operating income would decrease by $23,400 per year. E. None of the above.

Explanation / Answer

Answer:- The impact on the company’s overall net operating income of buying Part A42 from the outside supplier would be net operating income would decrease by $23400 per year.

Explanation:-1)-

2)-If the company has no alternative facilities that are now being used to produce the Part A42 , the financial disadvantages of buying 16000 units from outside supplier is

($30.40 per unit -$27.50 per unit)*16000 units =$46400

3)-Hence outside supplier’s offer should not be accepted.

4)-If Part A42 is purchase from outside supplier then Elgin Corporation can the use the freed capacity tom make more of one of the company’s others products, generating an additional segment margin of $23000 per year for that product.

Hence financial disadvantages will be =Segment margin from new product-Loss on purchase from outside supplier

                      =$23000-$46400 =($23400)

Hence the impact on the company’s overall net operating income of buying Part A42 from the outside supplier would be net operating income would decrease by $23400 per year.

5)Depreciation on special equipment is a sunk cost hence it is not a relevant cost, hence not considered.

6)- Allocated general overhead are unavoidable fixed cost hence not considered in relevant cost, it is continue to occur whether to manufacture the product or buy the product.

Elgin Corporation Statement of Comparative cost Manufaturing Amount Purchase from outside Supplier Amount Per unit $ Per unit $ Direct Material                  7.50 Purchase Cost               30.40 Direct Labor                  8.90 Variable Manufacuring Overhead 5.50 Supervisor salary 5.60 Total Manufaturing cost                27.50 Total Purchase cost               30.40

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