Schopp Inc. has been manufacturing its own shades for its table lamps. The compa

Question

Schopp Inc. has been manufacturing its own shades for its table lamps. The company is currently operating at 100% of capacity, and variable manufacturing overhead is charged to production at the rate of 60% of direct labor cost. The direct materials and direct labor cost per unit to make the lamp shades are $3.84 and $4.70, respectively. Normal production is 27,100 table lamps per year.
   A supplier offers to make the lamp shades at a price of $13.10 per unit. If Schopp Inc. accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $42,880 of fixed manufacturing overhead currently being charged to the lamp shades will have to be absorbed by other products.

Schopp Inc. has been manufacturing its own shades for its table lamps. The company is currently operating at 100% of capacity, and variable manufacturing overhead is charged to production at the rate of 60% of direct labor cost. The direct materials and direct labor cost per unit to make the lamp shades are $3.84 and $4.70, respectively. Normal production is 27,100 table lamps per year.
   A supplier offers to make the lamp shades at a price of $13.10 per unit. If Schopp Inc. accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but the $42,880 of fixed manufacturing overhead currently being charged to the lamp shades will have to be absorbed by other products.

Explanation / Answer

If the product is purchased the net income shall decrease by $47154

#Fixed cost is unavoidable in this case hence ignored for decision making.

If the productive capacity released generates an income of $66351, the table would be as under:

In this case it is better to purchase the product. income would increase by $19197

Make($) Buy($) Net Income Increase/ (Decrease)($) Direct Materials $3.84*27100 = 104064 0 104,064 Direct Labour $4.70*27100 = 127370 0 127,370 Variable Overheads Costs 60%*$4.70*27100 = 76422 0 76,422 Fixed Manufacturing Costs 0 0 0 Purchase Price $13.10*27100 = 355010 (355,010) Total Annual Cost 307856 355010 (47,154)

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