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 88,800 units per year is:

Direct materials	$	2.30
Direct labor	$	3.00
Variable manufacturing overhead	$	0.70
Fixed manufacturing overhead	$	3.75
Variable selling and administrative expenses	$	1.20
Fixed selling and administrative expenses	$	2.00

The normal selling price is $19.00 per unit. The company’s capacity is 111,600 units per year. An order has been received from a mail-order house for 1,900 units at a special price of $16.00 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

Solution:-

1. What is the financial advantage (disadvantage) of accepting the special order:-

Financial advantage

$ 16,720

Explanation:-

Particulars	Per unit	1,900 units
Incremental sales	16.00	30,400
Incremental costs:
Direct material	2.30	4,370
Direct labor	3.00	5,700
Variable manufacturing overhead	0.70	1,330
Variable selling and administrative	1.20	2,280
Total incremental cost	7.20	13,680
Financial advantage of accepting special order	8.80	16,720

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:-

Relevant cost per unit

$1.20

Explanation:-

The relevant cost is $1.20 (the variable selling and administrative expenses). All other variable costs are sunk because the units have already been produced. The fixed costs are not relevant because they will not change in total as a consequence of the price charged for the left-over units.

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