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 104,400 units per year is:

Direct materials	$	1.60
Direct labor	$	2.00
Variable manufacturing overhead	$	0.80
Fixed manufacturing overhead	$	4.65
Variable selling and administrative expenses	$	2.00
Fixed selling and administrative expenses	$	1.00

The normal selling price is $21.00 per unit. The company’s capacity is 138,000 units per year. An order has been received from a mail-order house for 2,800 units at a special price of $18.00 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

Financial Advantage = $ 32,480
	Workings	Amount
Additional Sales	2800 Units*18		50,400
Additional cost
Direct Material	2800 Units*1.6	4,480
Direct Labor	2800 Units*2	5,600
Variable manufacturing overhead	2800 Units*0.8	2,240
Variable selling and administrative	2800 Units*2	5,600	17,920
Financial Advantage			32,480
2
Relevant Cost per unit = $ 2 per unit
The relevant cost is $ 2 i.e. varfiable selling and administrative all the other costs are sunk cost as the goods have already been manufactured.

The fixed cost will not be taken into account because they will not change the total price.