E26-4 Shannon Inc. has been manufacturing its own shades for its table lamps. Th

ID: 2353053 • Letter: E

Question

E26-4

Shannon Inc. has been manufacturing its own shades for its table lamps. The company is currently operating at 100% of capacity. Variable manufacturing overhead is charged to production at the rate of 50% of direct labor cost. The direct materials and direct labor cost per unit to make the lamp shades are $4.00 and $6.00, respectively. Normal production is 40,000 table lamps per year.
A supplier offers to make the lamp shades at a price of $13.50 per unit. If Shannon Inc. accepts the supplier's offer, all variable manufacturing costs will be eliminated, but the $40,000 of fixed manufacturing overhead currently being charged to the lamp shades will have to be absorbed by other products.
Instructions

Complete the incremental analysis for the decision to make or buy the lamp shades.

Make----------- Buy------------ Net Income [Increase(Decrease)]

Direct materials $------ $------ $
Direct labor $------ $------ $
Variable manufacturing costs $------ $------ $
Fixed manufacturing costs $------ $------ $
Purchase price $------ $------ $

Total annual cost $------ $------ $

Should Shannon Inc. buy the lamp shades?

No/Yes

Would your answer be different if the productive capacity released by not making the lamp shades could be used to produce income of $35,000?

No/Yes

Explanation / Answer

Make

Buy

Net income increase(decrease)

Direct materials

160000

direct labor

240000

variable manufacturing costs

120000

fixed manufacturing costs

40000

purchase price

540000

-540000

total annual costs

560,000

580,000

-20000

Should Shannon Inc. buy the lamp shades?

No, they should not buy the lamp shades. Net income would decrease by 20,000.

Would your answer be different if the productive capacity released by not making the lamp shades could be used to produce income of $35,000?

Yes. Then it would be better to buy, and net income would increase by 15,000 in that case.