In: Accounting
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 60,000 units per year is:
Direct materials | $ | 5.10 |
Direct labor | $ | 3.80 |
Variable manufacturing overhead | $ | 1.00 |
Fixed manufacturing overhead | $ | 4.20 |
Variable selling and administrative expense | $ | 1.50 |
Fixed selling and administrative expense | $ | 2.40 |
The normal selling price is $21 per unit. The company’s capacity is 75,000 units per year. An order has been received from a mail-order house for 15,000 units at a special price of $14.00 per unit. This order would not affect regular sales.
Required:
1. If the order is accepted, by how much will annual profits be increased or decreased? (The order will not change the company’s total fixed costs.)
2. Assume the company has 1,000 units of this product left over from last year that are inferior to the current model. The units must be sold through regular channels at reduced prices. What unit cost is relevant for establishing a minimum selling price for these units? (Round your answer to 2 decimal places.)
step by step solution for your better understanding -
1.
To accept this order,
first select the relevant costs. As mentioned, the order will not change the company’s fixed costs. Hence fixed costs are irrelevant costs. Hence relevant costs are:
Direct Material |
$5.10 |
Add : Direct labor |
$3.80 |
: Variable Manufacturing overhead |
$1.00 |
: Variable selling and administrative expense |
$1.50 |
Total costs |
$11.40 |
Selling Price per unit |
$14.00 |
Contribution per unit ( $14.00 - $11.40 ) |
$2.60 |
Increase in net income for 15,000 units ($2.60 15,000) |
$39,000 |
The relevant cost per unit is $11.40 and selling price unit is $14.00. Hence there is a Contribution per unit of ( $14.00 - $11.40 ) = $2.60.
In view of the above,
there will be increase of net income by $39,000 by accepting the special order.
2.
The stock of this product is inferior to the current model. This should be sold at reduced price.
The relevant cost of the last year manufactured units is the cost incurred in current year.
Variable selling and administrative expense of $1.50 is the relevant cost while establishing minimum selling price for these units.
Production cost of such units will be irrelevant in decision making as it has already been incurred in previous year.
Hence,
the relevant cost for establishing minimum selling price is $1.50.