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	$	1.80
Direct labor	$	4.00
Variable manufacturing overhead	$	0.90
Fixed manufacturing overhead	$	5.05
Variable selling and administrative expenses	$	2.10
Fixed selling and administrative expenses	$	3.00

The normal selling price is $23.00 per unit. The company’s capacity is 126,000 units per year. An order has been received from a mail-order house for 1,900 units at a special price of $20.00 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. What unit cost is relevant for establishing a minimum selling price for these units?

Answer 1

1. Financial Advantage in accepting the special order is$ 21281.9($ 11.201per unit*1900units)

Statement of Profitability for the Special Order

Particulars	Per unit	Per unit
Sales Revenue		$ 20
Less: Direct Material	$ 1.80
Direct Labour	$ 4.00
Variable Manufacturing Overhead	$0.90
Variable Selling and Administrative Expenses	$2.10	$ 8.80
Contribution per unit on the Special Order		$ 11.201
Financial   Advantage due to accepting the Order		$ 11.201.

Financial Advantage in accepting the special order is $ 11.201 per unit

Fixed costs are not considered as relevant costs for this special order as there is surplus capacity in the organization and the fixed costs have already been paid for recovered by the normal production of 103200 units i.e these fixed costs are past or sunk costs so they need not be covered by the special order revenue.

2. With respect to 1000 units in the closing stock which are to be sold at reduced prices through the regular channels as they are inferior, the relevant costs for determining the minimum sales price is the Total Cost per unit =$ 16.85..This is so because these are the units that have been manufactured as a part of the normal production and therefore fixed costs are to be recovered against them. .