Question

Item I51 is used in one of Policy Corporation's products. The company makes 20,800 units of this item each year. The company's Accounting Department reports the following costs of producing Item 151 at this level of activity: Per Unit Direct materials $ 1.90 Direct labor $ 2.90 Variable manufacturing overhead $ 4.00 Supervisor’s salary $ 1.70 Depreciation of special equipment $ 3.40 Allocated general overhead $ 9.20 An outside supplier has offered to produce Item 151 and sell it to the company for $18.60 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 item 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 $31,600 of these allocated general overhead costs would be avoided. If management decides to buy Item I51 from the outside supplier rather than to continue making the Item, what would be the annual impact on the company's overall net operating income?

Answer 1

Impact on net income= $118,880

Step-by-step explanation:

Giving the following information:

Item I51 is used in one of Policy Corporation's products. The company makes 20,800 units.

Direct materials $ 1.90

Direct labor $ 2.90

Variable manufacturing overhead $ 4.00

Supervisor’s salary $ 1.70

Depreciation of special equipment $ 3.40

Allocated general overhead $ 9.20

Buy= 18.60

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 item was purchased many years ago and has no salvage value or other use. The allocated general overhead represents the fixed costs of the entire company. If the outside supplier's offer were accepted, only $31,600 of these allocated general overhead costs would be avoided.

Make in house:

We will only consider the incremental costs (those that varies on each option)

Direct materials $ 1.90* 20800= 39520

Direct labor $ 2.90=60320

Variable manufacturing overhead $ 4.00= 83200

Supervisor’s salary $ 1.70= 35360

Allocated general overhead= 31600

Total= $250,000

Buy:

18.60*20800= $368880

It is more convenient to continue producing in house.

Impact on net income= 368,880 - 250000= $118,880