Question

Rosey Industries manufacturing two smart educational toys: puzzleball and dreambox. The company has a long term contract to rent manufacturing equipment and necessary space for $900,000 per year and makes each product at a variable cost of $250 per unit. Currently, it makes 1,000 units of each product per year and sells puzzleballs for $800 and dreamboxes for $1,000 per unit. Last year's income statement using the contribution approach is shown below: Revenue $1,800,000 (puzzleballs: 1,000 units @ $800; dreamboxes: 1,000 units @ $1,000) Less: Variable Cost (2,000 units @ $250) (500,000) Contribution Margin 1,300,000 Less: Fixed Manufacturing Costs (900,000) Less: Selling, General and Admin Expenses (200,000) Operating Income $200,000 The president of the company is pondering how he should respond to a request for a bid brought in by the sales manager- requested by an overseas company. The request is from outside Rosey's usual and planned market areas, and is for a one time shipping of 500 units of dreamboxes. The overseas company would pay all the shipping costs and this would be a one time deal. Rosey believes this company only operates overseas, so accepting its order will have no effect on the company's normal sales. The president believes that the company currently has sufficient capacity to handle the additional 500 units of output without needing additional equipment or space. The deal will not affect Selling, General and Admin Expenses. In considering what price to bid, Rosey wants to first determine the minimum price that she can accept on the order without lowering the company's operating income. The sales manager has suggested a figure of $700 based on the following calculations: Variable manufacturing cost per unit $250 Fixed manufacturing cost per unit $450 Full manufacturing cost per unit $700 TO DO Based on the information provided, what is your advice to Rosey Industries? Compute unit costs for puzzleball and dreambox to support your response. Feel free to include any other information relevant to the decision making process.

Answer 1

Concept:

Unit Cost for Product:

Unit Cost for Product = Total of Variable Costs for Product + Total of Fixed Costs for Product / Number of Units Produced.

Selling, General & Admin Expenses are not included in Calculation of Unit Cost for Product. As it is Non-manufacturing cost matched with Period and not with Product.

Decision regarding Special Order.

If Regular Sales are unaffected ACCEPT SPECIAL ORDER If Revenue from the Order ≥ Incremental Cost that is Variable Costs.

As Fixed Production Costs are usually IRRELEVANT as they do not change whether or not the order is accepted.

Based on Above Explanation.

Minimum Price per unit for Order that will not reduce Operating Income = Variable Costs Per Unit. (As in this case increase in Operating Income will $0 as Order Price Per Unit = Variable Costs Per Unit and Fixed Costs and other Cost such as selling General and Admin Expenses will not changed due to Special order.

Answer:

Unit Cost for Puzzle ball = Total Variable Costs for Puzzle boll + Total Fixed Costs for Puzzle ball / Number of Units Produced (Puzzle ball)

$ 250,000* + $ 450,000* / 1,000 Units.

$ 700 Per Unit.

[Out of $ 700 Per Unit $ 450 is Fixed Costs Per Unit. Fixed costs Per Unit = Unit Cost Per Unit - Variable Costs Per Unit =$ 700 (Calculated) - $ 250(Given)]

Unit Cost for Puzzle ball will be = $ 700 Per Unit.

* WORKING:

Number of Units Produced (Puzzle ball) = 1,000 Units (Given)

Total Variable Costs for Puzzle ball= $ 250,000 [1,000 Units × $ 250 Per Unit (Given)]

Total Fixed Costs for Puzzle ball =Total Fixed Costs (for entire industry) × Number of Units Produced (Puzzle ball) /Total Unit Produced.

$900,000 × 1,000 / 2,000.

$ 450,000.

Note:

[Fixed Costs are allocated to both Product using their Respective volume of Production. Total Unit Produced = 2,000 Units (1,000 Units of Puzzle ball + 1,000 Units of Dreambox) ]

Unit Cost for Dreambox=  Total Variable Costs for Dreambox + Total Fixed Costs for Dreambox / Number of Units Produced (Dreambox).

$ 250,000** + $ 450,000** / 1,000** Units.

$ 700 Per Unit.

[Out of $ 700 Per Unit $ 450 Per Unit is Fixed Costs Per Unit. Fixed costs per unit = Unit Cost Per Unit - Variable Cost Per Unit = $ 700 (Calculated) - $ 250 (Given) ]

Unit Cost for Dreambox will be = $ 700 Per Unit.

** WORKING:

Number of units Produced (Dreambox) = 1,000 Units (Given).

Total Variable Costs for Dreambox = $ 250,000 [1,000 Units × $ 250 Per Unit (Given) ]

Total Fixed Costs for Dreambox = Total of Fixed Costs (for entire industry) × Number of Units Produced (Dreambox) / Total Units Produced.

$ 900,000 × 1,000 /2,000.

$ 450,000.

Note:

[Fixed costs are allocated to both the Product using their Respective volume of Production. Total Unit Produced = 2,000 Units (1,000 Units of Puzzle ball + 1,000 Units of Dreambox) ]

Advice to Rosey Industry.

Refer to Decision Regarding Special Order (MENTIONED IN CONCEPT).

The Minimum Sale Price ($ 700 Per Unit) suggested by Sales Manager is not Appropriate as it includes Fixed Manufacturing cost ($ 450 per unit).

As per Concept in case Special order in which No Normal Sale is Affected (Mentioned in Question) and No excess Capacity is required (As per President's Believe) and No effect on Selling General & Admin Expenses.

Minimum Sale Price for 500 Dreamboxes in above case = Variable Costs Per Unit=$200 Per Unit without lowering Company's operating income.***

*** As Sale Price Per Unit ($ 200) is equal to Variable Cost Per Unit ($ 200) and No Change in Other Expenses by Rosy Industry. Effect on Operating Income will $ 0 due to Special order not negative (lowering operating income).

Thus, Minimum Sale Price for 500 Dreamboxes will be $ 250 Per Unit instead of $ 700 Per Unit.