Answer:
Question is related on the decision making based on relevant cost whether to make or buy the product.
Relevant Cost is the cost which will be incurred in future and different under each alternative course of action. The following costs are considered as relevant cost:
- Direct material cost
- Direct labor cost
- Variable manufacturing overhead
- Variable Cost of Goods Sold
- Variable selling and administrative expenses
The above costs are the variable cost which will vary with the production volume. Hence these costs have both the characteristic of relevant cost i.e. it is a future cost and different under each alternative course of action.
Irrelevant cost is the costs which do not play any role in decision making. Irrelevant Cost is the SUNK Cost which has already been incurred and does not change whether company accept or reject the order. Hence it is treated as IRRELEVANT COST.
Relevant Cost for Making of Product and Buying from Outside
Make
Buy
Net Increase or (Decrease) in Operating Income if company buy the product from outside
Direct Material
$21,600
$0
$21,600
Direct Labor
$39,600
$0
$39,600
Variable manufacturing overhead
$59,400
$0
$59,400
Supervisor’s salary
$18,000
$0
$18,000
Purchase Price offered by the supplier
(18,000 Units x $15.80)
$284,400
-$284,400
Saving in general overhead if purchased from outside
$26,000
Net Increase or (Decrease) in operating income
-$119,800
Hence, the correct option is Net operating income would decline by $119,800 per year
