Question

Part D70 is used in one of Wally Corporation's products. The company's Accounting Department reports the following costs of producing the 10,000 units of the part that are needed every year.

	Per Unit
Direct Materials	$7.00
Direct Labor	$6.00
Variable Overhead	$5.00
Supervisor's Salary	$4.00
Depreciation of Special Equipment	$1.50
Allocated General Overhead	$5.50

An outside supplier has offered to make the part and sell it to the company for $25.00 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 $12,000 of these allocated general overhead costs would be avoided.

Prepare a report that shows the effect on the company's total net operating income of buying part D70 from the supplier rather than continuing to make it inside the company.

Answer 1

	Units Required	10000
		Per Unit	Total	Status
	Direct Materials	7.00	70,000	Avoidable
	Direct Labor	6.00	60,000	Avoidable
	Variable Overhead	5.00	50,000	Avoidable
	Supervisor's Salary	4.00	40,000	Avoidable
	Depreciation of Special Equipment	1.50	15,000	Sunk Cost
	Allocated General Overhead	5.50	55,000	Sunk Cost, Only 12000 Avoidable, Hence Relevant
		29.00	2,90,000
	Suppliers Offer	25.00
	Comparative Income Statement:	In House	Outside
	Direct Materials	70,000
	Direct Labor	60,000
	Variable Overhead	50,000
	Supervisor's Salary	40,000
	Allocated General Overhead-Rest Sunk	12000
	Purchases Cost		250000	25*10000
	Total Costs	2,32,000	2,50,000
	Loss in Buying over Manufacturing	18,000