Question

Harris Company has a current production level of 20,000 units per month. Unit costs at this level are:

Direct materials	$0.25
Direct labor	0.40
Variable overhead	0.15
Fixed overhead	0.20
Marketing - fixed	0.20
Marketing/distribution - variable	0.40

Current monthly sales are 18,000 units. Jimi Company has contacted Harris Company about purchasing 1,500 units at $2.00 each. Current sales would not be affected by the one-time-only special order, and variable marketing/distribution costs would not be incurred on the special order. What is Harris Company's change in operating profits if the special order is accepted?

	A.	$400 decrease in operating profits
	B.	$400 increase in operating profits
	C.	$1,800 decrease in operating profits
	D.	$1,800 increase in operating profits

Answer 1

• Points to consider:

--Normal sale will not be affected.

--No additional fixed cost will be incurred.

--Operating profits will increase so far as the offered price of $ 2 per unit is MORE than variable relevant cost,

• Relevant Variable cost per unit:

Direct Material	$                     0.25
Direct Labor	$                     0.40
Variable Overhead	$                     0.15
Variable marketing	$                          -
Total variable cost per unit	$                     0.80

• Hence, Relevant cost of $ 0.80 per unit is LESS than offered price of $ 2 per unit. This means that operating profits will increase.
• Operating profits will increase by $ 1.2 per unit. Total increase = 1500 units x 1.2 = $ 1,800
• Correct Answer = Option ‘D’ $ 1,800 increase in operating profits