Question

GEM Limited has a single product Flicks. The company normally produces and sells 80,000 units of Flicks each year at a price of $240 per unit. The company’s unit costs at this level of activity are as follow: Direct material Direct labour Variable manufacturing overhead Fixed manufacturing overhead Variable selling and administrative costs Fixed selling and administrative costs Total unit cost $57.00 60.00 16.80 30.00 10.20 27.00 $201.00 GEM has sufficient capacity to produce 100 000 units of Flicks a year without any increase in fixed manufacturing overhead. Required: (a) GEM has an opportunity to sell 10 000 units to an overseas customer. Import duties and other special costs associated with this order would total $42 000. The only selling costs that would be associated with the order would be a shipping cost of $9.00 per unit. What would be the minimum acceptable unit price for GEM to consider this order? (hint: GEM would not accept the order if it would reduce the company’s profit) (b) The company has 200 units of Flicks on hand that were produced two months ago. Due to blemishes on the units, it will be impossible to sell these units at the normal price. If the company wishes to sell them through regular sales channels, what would be the relevant cost for setting the minimum price? Explain. (c) “All future costs are relevant in decision making.” Do you agree?

Answer 1

Information provided the question are as follows:

Particulars	Units
Total capacity	100,000
Normal production and sales	80,000

Particulars	Amount in $	Amount in $
Selling price		240
Less: Costs
Direct material	57
Direct labour	60
Variable manufacturing overhead	17
Fixed manufacturing overhead	30
Variable selling and administrative costs	10
Fixed selling and administrative costs	27	201
Profit per unit [240 - 201]		39

Answer to question A

Given, opportunity to sell 10 000 units to an overseas customer

Objective: Find the dinimum acceptable unit price for GEM to consider this order [Hint: GEM would not accept the order if it would reduce the company’s profit]

Step 1: Calcuate the toal additional benefits from the new order

Particulars	Amount in $	Amount in $
Additional profit [10,000 units X 39]		390,000
Less: Additional costs specific to international order
Import duties and other special costs	42,000
Shipping cost @ $ 9 per unit [ 10,000 X 9]	90,000	132,000
Total costs
Net additional profit from the new order		258,000

Step 2: Calcuation minimum acceptable unit price

Particulars	Amount in $
Normal selling price per unit	240
Less:
Net additional profit from the new order per unit [258,000/10,000]	25.8
Minimum price	214.2

As GEM Limited would neither make profit not loss if it prices per unit for the new internation order at $214 per unit. Therefore the minimum acceptable price per unit is $214.2 per unit.

Anser to Qestion B

In the present case, the relevant cost for setting the minimum price would be the cost that will need to be incurred to sell the product.

The costs (Direct material Direct labour Variable manufacturing overhead Fixed manufacturing overhead etc.) which was incurred to manufacture the products are sunk costs and do not have any relevance in decision making.

Answer to Qestion C

No, all future costs are not relevant in deicision making.Future variable costs which are same under various alternatives are not relevant for decision making. For insatance, in the below example material cost will not be relevant for decision making because it is $5 in both the options.

Particulars	Option A	Option B
Material cost $	5	5
Direct labour per unit $	5	4