Part J88 is used in one of Quinney Corporation's products. The company makes 3,000 units of this part each year. The company's Accounting Department reports the following costs of producing the part at this level of activity:
Direct materials--$7.70 per unit
Direct labor--$6.00 per unit
Variable manufacturing overhead $8.00
Supervisor's salary $7.60
Depreciating of special equipment--$5.90
Allocated general overhead--$3.30
An outside supplier has offered to produce this part and sell it to the company for $32.10 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 $3,000 of these allocated general overhead costs would be avoided.
If management decides to buy part J88 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 $22,200 per year.
B. Net operating income would decline by $16,200 per year.
C. Net operating income would decline by $5,400 per year.
D. Net operating income would decline by $19,200 per year.
To consider the impact we need to compare the costs which are avoided with the purchase price.
The avoidable costs are
Direct materials= 7.70 ...
The solution determines the annual impact on the company's overall net operating income.