Question

Kintek Ltd produces electronic calculators. The firm recently received a special-order inquiry from Anderson Electronics Inc. which has offered to purchase a large order of 6,000 calculators for a price of $38 each. Kintek’s normal selling price for the calculator is $55.

The cost data for one calculator is as follows:
Direct material $16
Direct labour 7
Manufacturing overhead 17
Variable selling expense   5
Total unit cost   $45

Additional information:

• Kintek has decided that, if it accepts the order, it will purchase additional specialized equipment costing $4,500 and will spend an additional $5,000 in set up costs.
• The manufacturing overhead costs include $6 of variable overhead and $11 of fixed overhead per unit.
• There would be no shipping expense or sales commission on the special order, so 60% of the variable selling expense would be eliminated.
• Kintek would allocate $3,000 of fixed administrative costs to the order as “part of the cost of doing business”.
• Kintek has sufficient unused capacity to produce the order.

Required:

1. Assume regular sales would not be affected by this special order. Should Kintek Ltd accept the order? By how much would profit increase or decrease if the order is accepted? Show your work.

2. Assume that by accepting this order Kintek Ltd would lose 1,000 units of regular sales.
   1. Calculate the opportunity cost from accepting the special order.
   2. Should Kintek accept the special order in this situation? (1 mark)

3. Refer to the original cost data. Kintek Ltd has 100 of last-years’ model calculators that it has been unable to sell, even at a reduced price. Another company, Bailey’s Bargain Basement Stores Ltd. has agreed to buy all 100 last year’s calculators from Kintek if the “price is right”. The agreement specifies that Kintek would have to pay $3 per calculator to have the batteries replaced. Assume that no selling expenses would be incurred and that the other unit costs (given above) have not changed since 2013. What is the minimum price that Kintek should charge Bailey’s? Show your work for full marks. (1 mark)

Answer 1

a. Statement showing the evaluation of the proposal from Anderson Electronics Inc. and profit or loss thereto:

Given information relating produce of electronic calculators.

Normal Selling Price is $55

Direct material is $16

Direct labour is $7

Manufacturing overhead is $17 out of this Varaible manufacturing overhead is $6 and Fixed manufacturing overhead is $11

Variable selling expense is $5

Statement of income if the special order is accepted:

	Per Unit	Total (6,000 Calculators)
Sales Revenue	$38	$228,000
Less: Costs
Direct Material	$16	$96,000
Direct Labour	$7	$42,000
Variable Manufacturing Overhead	$6	$36,000
Variable Selling Expense	$2 ($5 * 40%)	$12,000
Allocated Fixed Administrative Cost		$3,000
Purchase of specialized equipment		$4,500
Additional Setup Costs		$5,000
Total Costs incurred		$198,500
Net income from accepting special order ($228,000 - $198,500)	$29,500

The net income from accepting the special order is $29,500.

Note:

1. In considering the special offer, only the relevant costs incurred for manufacturing the product will be considered i.e. the additional costs incurred.

2. 60% of the variable selling expense can be eliminated. Hence it will not form part of the relevant cost.

3. Fixed cost will not be considered for evaluating the special offer. Only the allocated fixed cost will be considered. Hence the Fixed Administrative Cost allocated for the product is $3,000 has been considered.

2. Calculate of opportunity cost from accepting the special order, if 1,000 units of regular sales have been lost:

	Per Unit	Total (1,000 Calculators)
Sales Revenue	$38	$38,000
Less: Costs
Direct Material	$16	$16,000
Direct Labour	$7	$7,000
Variable Manufacturing Overhead	$6	$6,000
Variable Selling Expense	$5	$5,000
Total Costs incurred		$34,000
Loss of revenue from 1,000 calculators($38,000 - $34,000)		$4,000
Net income from special order		$29,500
Opportunity cost from accepting special order is ($29,500 - $4,000)		$25,500

Decision: From the above we can observe that the opportunity cost from accepting the order results in $25,500. The company can accept the order.

3. Minimum price that Kintek should charge Bailey’s for 100 of last-years model calculators:

Given information:

Kintek Ltd has 100 of last-years’ model calculators that it has been unable to sell, even at a reduced price.

This cost has already been incurred previously and hence such cost shall not be considered for decision making because it is a SUNK COST.

In a decision making, only relevant cost i.e. the additional cost to be incurred will be considered.

The given question, the agreement specifies that Kintek would have to pay $3 per calculator to have the batteries replaced. Only this cost will be considered because it is yet to incurred.

Hence the minimum price that the Kintek should charge will be $3 per calculator.