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 85,200 units per year is: Direct materials $ 2.40 Direct labor $ 3.00 Variable manufacturing overhead $ 0.80 Fixed manufacturing overhead $ 4.65 Variable selling and administrative expenses $ 1.20 Fixed selling and administrative expenses $ 2.00 The normal selling price is $24.00 per unit. The company’s capacity is 99,600 units per year. An order has been received from a mail-order house for 1,200 units at a special price of $21.00 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. If we accept the Special order our net income will increase by $ 17,760 from the ideal capacity.

So the financial advantage is that we are getting extra income by using our existing idle capacity.

Below are the calculations:

	Per Unit	Normal Activity	Special Order	Total
No. of Units		85200	1200	86400
SP	24 & 21	2,044,800	25,200	2,070,000
Less: Variable Costs
Material	2.40	204,480	2,880	207,360
Labour	3.00	255,600	3,600	259,200
Manufactring Overhead	0.80	68,160	960	69,120
Contribution		1,516,560	17,760	1,534,320
Fixed Manufactring OH	4.65	396,180	-	396,180
Variable Selling Expenses	1.20	102,240		102,240
Fixed Selling Expenses	2.00	170,400		170,400
Net Income		847,740	17,760	865,500

So, since Delta company currently have idle capacity so the company will accept the offer as it will increase the net income.

2. Minimum Selling Price per unit will be $ 6.20.

No. of Units	1000
Material	2,400.00
Labour	3,000.00
Manufacturing Overhead	800.00
Total Cost	6,200.00
Price Per Unit	6.20

Since these units are from opening units we are not going to incur any further costs to Sale this. We can sale at a minimum price of Cost of Manufacture i.e 6.20.