Question

Delta Company produces a single product. The cost of producing and selling a single unit of this product at the company’s normal activity level of 103,200 units per year is:

Direct materials	$	2.30
Direct labor	$	3.00
Variable manufacturing overhead	$	0.90
Fixed manufacturing overhead	$	4.45
Variable selling and administrative expenses	$	1.20
Fixed selling and administrative expenses	$	2.00

The normal selling price is $22.00 per unit. The company’s capacity is 139,200 units per year. An order has been received from a mail-order house for 3,000 units at a special price of $19.00 per unit. This order would not affect regular sales or the company’s total fixed costs.

Required:

1. What is the financial advantage (disadvantage) of accepting the special order?

2. As a separate matter from the special order, assume the company’s inventory includes 1,000 units of this product that were produced last year and that are inferior to the current model. The units must be sold through regular channels at reduced prices. What unit cost is relevant for establishing a minimum selling price for these units?

Answer 1

1. To accept this special order, first elect the relevant costs.The order will not change the company's fixed cost are irrelevant costs.Hence relevant costs are:

Direct material	$2.30
Add: Direct labour	$3.00
Add:Variable manufacturing overhead	$0.90
Add:Variable selling & administrative overhead	$1.20
Total cost	$7.40
Selling price per unit	$19
Contribution per unit	$11.6
Increase in net income for 3000 units ($11.6*3000)	$34,800

In the view of the above there will be increase of net income by $34,800 by accepting the special order.

2) The stock of this product is inferior to the current model.This should be sold at reduced price.The relevant cost of the last year manufactured units is the cost incurred in the current year.Variable selling & administrative expenses of $1.20 is the relevant cost while establishing minimum selling price for these units .Production cost of such units will be irrelevant in decision making as it has already been incurred in previous year.

Hence the relevant cost for establishing minimum selling price is $1.20.

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