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 104,400 units per year is:

Direct materials	$	1.50
Direct labor	$	3.00
Variable manufacturing overhead	$	0.70
Fixed manufacturing overhead	$	4.15
Variable selling and administrative expenses	$	1.50
Fixed selling and administrative expenses	$	2.00

The normal selling price is $23.00 per unit. The company’s capacity is 136,800 units per year. An order has been received from a mail-order house for 2,700 units at a special price of $20.00 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 Ans:

• The company’s capacity is 136,800 units per year
• Normal activity level of 104,400 units per year is:
• so there exist spare capacity of 32,400units (136,800 - 104,400)
• Received from a mail-order house for 2,700 units that order is with in the capacity limits
• so Relevant cost to Accept the order is only variable cost and fixed cost is irrelevant
• special price per unit $20
• financial Advantage =2,700units($20 - $6.70)=$35,910

working:

Relevant cost	Per unit
Direct Material	$   1.50
Direct Labor	$   3.00
Variable Manufacturing Overheads	$   0.70
Variable selling and administrative expenses	$   1.50
Total relevant Cost	$   6.70

2)Ans

Relevant Cost per Unit =$1.50

Here is relevant cost will be the additional cost that will be paid on 1000 units. Since 1000 units are produced in earlier year so Direct material, Direct labor, variable MOH are already incurred so All production cost is a sunk cost for this decision.

Selling and administrative cost is relevant because selling cost is not paid until goods are sold so only selling cost per unit is relevant.