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 86,400 units per year is:

Direct materials	$	2.10
Direct labor	$	2.00
Variable manufacturing overhead	$	0.80
Fixed manufacturing overhead	$	5.05
Variable selling and administrative expenses	$	2.00
Fixed selling and administrative expenses	$	1.00

The normal selling price is $24.00 per unit. The company’s capacity is 103,200 units per year. An order has been received from a mail-order house for 1,400 units at a special price of $21.00 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. The company does not expect the selling of these inferior units to have any effect on the sales of its current model. What unit cost is relevant for establishing a minimum selling price for these units?

Answer 1

Solution

Delta Company

1. Determination of the financial advantage (disadvantage) of accepting the special order:

Special order price      $21

Variable unit cost of the product –

Direct materials          $2.10

Direct labor                 $2.00

Variable MOH            $0.80

Variable S&A             $2.00

Variable cost per unit $6.90

Contribution margin on the special order = 21 – 6.90 = $14.10 per unit

Special order units = 1,400 units

Contribution margin on special order = = 1,400 x $14.10 = $19,740

Financial advantage of accepting the special order = $19,740

Yes, the special order should be accepted.

Note: the fixed manufacturing overhead and selling overhead are not relevant for computing the financial advantage. These costs are fixed for a capacity of 103,200 units per year. Since, the acceptance of the special order would make the annual capacity to be 86,400 units + 1,400 units = 87,800 units, which is within the range of company’s annual capacity, the fixed costs are not relevant for the decision.

2. Determination of the unit cost relevant for establishing a minimum selling price for 1,000 inferior units:

The unit relevant cost for establishing a minimum price for the 1,000 units is the variable selling cost per unit of $2.00.

Since, the units are already produced, the direct costs such as the direct material, direct labor and variable manufacturing overhead cost are all not relevant.