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 103,200 units per year is:

Direct materials	$	2.10
Direct labor	$	2.00
Variable manufacturing overhead	$	0.60
Fixed manufacturing overhead	$	5.15
Variable selling and administrative expenses	$	1.20
Fixed selling and administrative expenses	$	1.00

The normal selling price is $21.00 per unit. The company’s capacity is 124,800 units per year. An order has been received from a mail-order house for 1,800 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

Answer -

1	Selling price per unit $		$18
	Variable costs:
	Direct materials	$2.1
	Direct labor	$2
	Variable manufacturing overhead	$0.6
	Variable selling and administrative expenses	$1.2
	Total variable costs		$5.9
	Contribution per unit $		$12.10
	Number of units ordered		1800
	Financial advantage of accepting the special order $		$21780

Fixed manufacturing overheads and fixed selling and administrative expenses are irrelevant as they would not be affected by the special order.

Note: Variable selling and administrative expenses are relevant to the special order only to the extent of administrative costs since selling costs may not have to be incurred since the order has been received without any additional efforts or cost. However, since the question is silent regarding the same, this cost is considered in the special order costing.

2. The unit cost relevant for establishing a minimum selling price for the inferior units produced last year is the variable selling and administrative costs of $1.20 per unit. These are the only future costs that will have to be incurred for selling the units and hence are relevant.

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