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Relevant and Irrelevant Costs

Skanda Inc. manufactures table lamps, and it has traditionally made its own lampshades for its lamps. It computes the cost of manufacturing each lampshade as follows:
Direct materials $4.00
Direct labor 6.00
Applied variable overhead 50% of direct labor cost

Skanda currently manufactures 40,000 table lamps and lamp shades per year and is currently operating at 100% of plant capacity.
A supplier has offered to produce the lamp shades for Skanda for $13.50 per unit. If Skanda accepts the supplierĆ¢??s offer, all of the variable overhead costs associated with manufacturing the lamp shades will be eliminated. Skanda is currently applying $40,000 of its fixed manufacturing overhead costs to the lamp shade production: These costs will not be eliminated, and they will now have to be applied to other products, increasing the cost of those other products.
1. Identify the costs that are relevant and the costs that are irrelevant to deciding whether to continue manufacturing the lamp shades or to purchase shades from this vendor.
2. Indicate the amount by which the decision to purchase the lamp shades instead of continuing to manufacture them would change SkandaĆ¢??s total costs. Should Skanda continue to manufacture lamp shades, or should the company begin purchasing them from this supplier?


Solution Summary

Relevant and irrelevant costs are examined.