Muzik Corporation uses part X43 in one of its products. The company's Accounting Department reports the following costs of producing the 16,000 units of the part that are needed every year. Per Unit Direct materials$2.90 Direct labor 3.90 Variable overhead 6.70 Supervisor's salary 7.20 Depreciation of special equipment 8.30 Allocated general overhead$5.40 An outside supplier has offered to make the part and sell it to the company for $28.00 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 $22,000 of these allocated general overhead costs would be avoided. In addition, the space used to produce part X43 could be used to make more of one of the company's other products, generating an additional segment margin of $22,000 per year for that product.Required:a. Prepare a report that shows the effect on the company's total net operating income of buying part X43 from the supplier rather than continuing to make it inside the company.b. Which alternative should the company choose?
What will be an ideal response?
a.
| Make | Buy | ||||||
| Direct materials (16,000 units × $2.90 per unit) | $ | 46,400 | |||||
| Direct labor (16,000 units × $3.90 per unit) | 62,400 | ||||||
| Variable overhead (16,000 units × $6.70 per unit) | 107,200 | ||||||
| Supervisor's salary (16,000 units × $7.20 per unit) | 115,200 | ||||||
| Depreciation of special equipment (not relevant) | 0 | ||||||
| Allocated general overhead (avoidable only) | 22,000 | ||||||
| Outside purchase price (16,000 units × $28.00 per unit) | $ | 448,000 | |||||
| Opportunity cost | (22,000 | ) | |||||
| Total cost | $ | 353,200 | $ | 426,000 | |||
The total cost of the make alternative is lower by $72,800. Thus, net operating income would decline by $72,800 if the offer from the supplier were accepted. Therefore, the company should continue to make the part itself.
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