Item I51 Is Used in One of Policy Corporation's Products

question 6

Multiple Choice

Item I51 is used in one of Policy Corporation's products. The company makes 18,000 units of this item each year. The company's Accounting Department reports the following costs of producing Item 151 at this level of activity:
$\begin{array}{ll}&\text { Per Unit }\\ \text { Direct materials } & \$ 1.20 \\\text { Direct labor } & \$ 2.20 \\\text { Variable manufacturing overhead } & \$ 3.30\\\text { Supervisor's salary } & \$ 1.00 \\\text { Depreciation of special equipment } & \$ 2.70 \\\text { Allocated general overhead } & \$ 8.50\end{array}$
An outside supplier has offered to produce Item 151 and sell it to the company for $15.80 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 $26,000 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?

• A) Net operating income would decline by $81,800 per year.
• B) Net operating income would decline by $55,800 per year.
• C) Net operating income would decline by $119,800 per year.
• D) Net operating income would decline by $29,800 per year.

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Definitions:

Gross Profit Ratio

A financial metric used to assess a company’s financial health by dividing gross profit by net sales.

Lost Inventory

Inventory that is unaccounted for due to theft, damage, or error, leading to discrepancies in stock records.

Gross Profit Method

The Gross Profit Method estimates the cost of goods sold and the ending inventory value by applying the company's average gross profit percentage to its net sales.

Lower Of Cost

An accounting principle that values inventory at the lower of its historical cost or market value.