Question

Landor Appliance Corporation makes and sells electric fans. Each fan regularly sells for $48. The following cost data per fan is based on a full capacity of 151,000 fans produced each period.

Direct materials	$	7
Direct labor	$	9
Manufacturing overhead (50% variable and 50% unavoidable fixed)	$	6

A special order has been received by Landor for a sale of 25,000 fans to an overseas customer. The only selling costs that would be incurred on this order would be $6 per fan for shipping. Landor is now selling 126,000 fans through regular channels each period. Assume that direct labor is an avoidable cost in this decision. What should Landor use as a minimum selling price per fan in negotiating a price for this special order?

Answer 1

Answer : In the given question we are required to compute the minimum selling price per fan Landor should use in negotiating a price for this special order. Hence the minimum price of a product to be equal to thesum of the additional costs that are incurred as a result of acceptance of an order / decision, i.e which can be avoided if the order is not accepted. Thus for minimum price Only those costs are relevant to a decision that can be avoided if the decision is not implemented. The Costs associated with each unit of fan is given below.

Costs	Per unit
Direct materials	$	7
Direct labor	$	9
Manufacturing overhead (50% variable and 50% unavoidable fixed)	$	6
Selling costs $6

Computation of the minimum price to be quoted

a)Direct Material Per Unit	$7
b)Labor Per unit	$9
c)Variable Overhead per unit( Note1)	$3
d)Selling cost	$6
Minimum Price(a+b+c+d)	$25

Note 1 :  Since its given in the information provided by the question that the manufacturing overhead are 50% variable and 50% unavoidable fixed, hence we can conclude that the Variable Overhead = (6*50%) = $3/unit , Unavoidable Fixed overhead /unit= 3

Note 2) : the Variable Overhead =$3/unit is a relevant cost for the computation of minimum price as this cost is incremental and avoidable for the special order, while as Unavoidable Fixed overhead /unit= $3 is not relevant for determination of the minimum price as this cost will be incurred irrespective of the acceptance of the special order.

Note 3) : As given in the question ,The only selling costs that would be incurred on this order would be $6 per fan for shipping. Hence it is Avoidable Cost which is relevant for a decision as it can be avoided if the decision is not implemented.