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 97,200 units per year is:

Direct materials	$	2.30
Direct labor	$	2.00
Variable manufacturing overhead	$	0.60
Fixed manufacturing overhead	$	4.05
Variable selling and administrative expenses	$	1.20
Fixed selling and administrative expenses	$	1.00

The normal selling price is $20.00 per unit. The company’s capacity is 110,400 units per year. An order has been received from a mail-order house for 1,100 units at a special price of $17.00 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

1

Computation of financial advantage of accepting the special order

Particulars	Per unit	1100 units
Sale value	$17	$18700
Less: Variable costs
Direct material	$2.30	($2530)
Direct labor	$2.00	($2200)
Variable manufacturing overhead	$0.60	($660)
Variable selling and administrative expense	$1.20	($1320)
Financial advantage of accepting the special order		$11990 (Ans)

We will not consider fixed costs as they have already been incurred in company's normal production of 97200 units. These 1100 units are a special order over and above the normal activity and will include only variable expenses

2

Relevant unit cost = $1.20 variable selling and administrative expense (Ans)
This is because the units are already produced last year, so no production costs will be incurred this year, however Variable selling and administrative expense is the only cost that will be incurred if these additional 1000 units are sold, so they will be relevant for establishing a minimum selling price for these units

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