Question

Simun Company makes and sells a product that regularly sell for $38.95 each.

The following information is available for the current year:

Annual maximum capacity in units	6,500
Current annual production in units	6,200
Budgeted absorption cost per unit:
Direct materials	$9.95
Direct labor	$2.65
Manufacturing overhead (70% variable)	$3.40

A new customer approached the company with a one-time all-or-nothing order for 700 units. The special-order units are identical to the regular ones, with one exception: the customer would like their business logo engraved on each unit. It will cost $3 to engrave the logo.

Q) The minimum total sales revenue from the special order that would be acceptable to the company is:

Answer 1

Answer)

Calculation of minimum total sales revenue

Minimum sales revenue should be based on the relevant cost of the special order. Relevant cost includes cost to be incurred due to acceptance of special order Plus benefit to be lost due to acceptance of special order.

Particulars	Amount (In $)
Cost to be incurred due to acceptance of special order:
Direct Materials (700 units X $ 9.95 per unit)	6,965
Direct Labor (700 units X $ 2.65 per unit)	1,855
Variable Manufacturing overhead ($ 3.40 X 70% X 700 units)	1,666
Total cost to be incurred due to acceptance of special order	10,486
Add: benefit to be lost due to acceptance of special order	9,588
Minimum Total Sales revenue from the special order	20,074

Therefore minimum sales revenue from the special order that would be acceptable to the company is $ 20,074.

Note: Fixed manufacturing overhead (i.e. 30% of total manufacturing cost) is a sunk cost being unavoidable in nature and should not be considered for calculation of relevant cost.

Working Note:

Calculation of benefit to be lost due to acceptance of special order:

The company has spare capacity of 300 units (i.e. 6,500 units – 6,200 units). However, the special order is of 700 units. Out of these 700 units, 300 units will be manufactured within spare capacity and balance 400 units will be required to be cut back from regular production. Therefore the contribution margin from those 400 units is the opportunity cost for the special order (i.e. benefit to be lost due to acceptance of special order).

Particulars	Amount (In $)
Sales (400 units X $ 38.95)	15,580
Less: Direct Material (400 units X $ 9.95)	3,980
Less: Direct Labor (400 units X $ 2.65)	1,060
Less: Variable Manufacturing overhead ($ 3.40 X 70% X 400 units)	952
Contribution margin	9,588

Therefore if the special order is accepted the company will lose $ 9,588 due to cut back of sales of regular units.

Note: Fixed manufacturing overhead (i.e. 30% of total manufacturing cost) is a sunk cost being unavoidable in nature and should not be considered for calculation of opportunity cost.