Question

TF Qu. 12-05 ADL company produces a single component with...

ADL company produces a single component with variable and fixed production costs of $7 and $3. The product currently sells for $12 per unit. The company is currently operating at 50% of its 10,000 unit annual production capacity. A customer recently approached the company with a one-time special order for 5,000 units, offering the company only $10 per unit. Because of the specific nature of this order, the company would have to invest in a special machine (which would cost an additional $10,000) to satisfy this order. Variable production costs would remain unchanged. If the special order was accepted, the machine would be sold immediately after the order was delivered for $2,000. Should the company accept the special order?

Multiple Choice

• Yes, as the company would earn an additional $15,000.

• Yes, as the company would earn an additional $7,000.

• No, as the company would lose $15,000.

• No, as the company would lose $7,000.

Answer 1

Answer)

Statement of Cost Benefit from the Special Order (5,000 units)

Particulars	Amount Per unit ($)
Sales (5,000 units X $ 10.00 per unit)	50,000
Total Sales Value (A)	50,000
Relevant Cost of production
Variable manufacturing cost (5,000 units X $ 7.00 per unit)	35,000
Purchase Cost of machinery net of resale value ($ 10,000 - $ 2,000)	8,000
Total Cost (B)	43,000
Net Additional Benefit (A - B)	7,000

Decision: Yes, the special order to manufacture additional 5,000 units of the component should be accepted as it the company will earn additional $ 7,000.

Notes:

· Fixed Production cost of $ 3.00 per unit has not been considered as it is a sunk cost being unavoidable in nature.

· Since, the machinery of $ 10,000 is specifically purchased for the order, its purchase cost is a relevant cost for the special order. However, since the machine will be sold immediately after the special order, its sales realization has been reduced from the relevant cost.

· There will be no contribution loss due to acceptance of Special order since the aggregate quantity of special order (5,000 units) and regular production (5,000 units) is equal to the total production capacity of the company (10,000 units).