Question

Item N29 is used by Tyner Corporation to make one of its products. A total of 12,000 units of this Item are produced and used every year. The company's Accounting Department reports the following costs of producing Item N29 at this level of activity:

	Per Unit
Direct materials	$	6.90
Direct labor		2.70
Variable manufacturing overhead		5.90
Supervisor’s salary		3.10
Depreciation of special equipment		4.20
Allocated general overhead		3.70

An outside supplier has offered to make Item N29 and sell it to the company for $25.20 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 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, none of which would be avoided if the Items were purchased instead of produced internally. In addition, the space used to make Item N29 could be used to make more of one of the company's other products, generating an additional segment margin of $30,000 per year for that product. What would be the impact on the company's overall net operating income of buying Item N29 from the outside supplier?

Answer 1

	Per unit		Total 12000 units
	Make	Buy	Make	Buy
Direct materials	6.90		82800
Direct labor	2.70		32400
Variable manufacturing overhead	5.90		70800
Supervisor’s salary	3.10		37200
Opportunity cost			30000
Purchase cost		25.20		302400
Total			253200	302400

Difference in favor of making = 302400-253200 = $49200

Net operating income would decline by $49,200 per year.