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.
(a) Prepare the incremental analysis for the decision to make or buy the lamp shades.
(b) Should Shannon Inc. buy the lamp shades?
(c) Would your answer be different in (b) if the productive capacity released by not making the lamp shades could be used to produce income of $35,000?