Question

Andretti Company has a single product called a Dak. The company normally produces and sells 87,000 Daks each year at a selling price of $60 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	8.50
Direct labor		12.00
Variable manufacturing overhead		2.90
Fixed manufacturing overhead		8.00	($696,000 total)
Variable selling expenses		3.70
Fixed selling expenses		3.50	($304,500 total)
Total cost per unit	$	38.60

A number of questions relating to the production and sale of Daks follow. Each question is independent.

Required:

1-a. Assume that Andretti Company has sufficient capacity to produce 104,400 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 20% above the present 87,000 units each year if it were willing to increase the fixed selling expenses by $120,000. What is the financial advantage (disadvantage) of investing an additional $120,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 104,400 Daks each year. A customer in a foreign market wants to purchase 17,400 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $2.70 per unit and an additional $15,660 for permits and licenses. The only selling costs that would be associated with the order would be $2.40 per unit shipping cost. What is the break-even price per unit on this order?

3. The company has 700 Daks on hand that have some irregularities and are therefore considered to be "seconds." Due to the irregularities, it will be impossible to sell these units at the normal price through regular distribution channels. What is the unit cost figure that is relevant for setting a minimum selling price?

4. Due to a strike in its supplier’s plant, Andretti Company is unable to purchase more material for the production of Daks. The strike is expected to last for two months. Andretti Company has enough material on hand to operate at 25% of normal levels for the two-month period. As an alternative, Andretti could close its plant down entirely for the two months. If the plant were closed, fixed manufacturing overhead costs would continue at 40% of their normal level during the two-month period and the fixed selling expenses would be reduced by 20% during the two-month period.

a. How much total contribution margin will Andretti forgo if it closes the plant for two months?

b. How much total fixed cost will the company avoid if it closes the plant for two months?

c. What is the financial advantage (disadvantage) of closing the plant for the two-month period?

d. Should Andretti close the plant for two months?

5. An outside manufacturer has offered to produce 87,000 Daks and ship them directly to Andretti’s customers. If Andretti Company accepts this offer, the facilities that it uses to produce Daks would be idle; however, fixed manufacturing overhead costs would be reduced by 30%. Because the outside manufacturer would pay for all shipping costs, the variable selling expenses would be only two-thirds of their present amount. What is Andretti’s avoidable cost per unit that it should compare to the price quoted by the outside manufacturer?

Answer 1

Solution:

In this type of question, the relevant cost is considered for decision making.

Relevant Cost is the cost which will be incurred in future and different under each alternative course of action. The following costs are considered as relevant cost:

- Direct material cost

- Direct labor cost

- Variable manufacturing overhead

- Variable Cost of Goods Sold

- Variable selling and administrative expenses

- Fixed Cost which is directly related to the alternative course of action.

The future costs which are different under each alternative course of action are called relevant cost. Hence these costs have both the characteristic of relevant cost i.e. it is a future cost and different under each alternative course of action.

Sometimes there are some fixed costs which will directly associated with the production or increase production units and have characteristics of relevant cost. i.e. future cost and different under each alternative course of action. In this question special tool cost is this type of cost.

Irrelevant cost is the costs which do not play any role in decision making. Irrelevant Cost is the SUNK Cost which has already been incurred and does not change whether company accept or reject the order. Hence it is treated as IRRELEVANT COST.

Note – Fixed manufacturing and selling costs are not considered relevant because these are fixed and not for the specific job. In decision making fixed costs are treated as period cost and not taken for decision making. Fixed Costs are irrelevant cost for decision making.

Note – Traceable fixed costs is considered relevant because they are traceable with the product directly and can be avoided if the product is not manufactured.

Part 1(a) – Financial advantage (disadvantage) of investing an additional $120,000 in fixed selling expenses

	$ per unit
Direct materials	$8.50
Direct labor	$12.00
Variable manufacturing overhead	$2.90
Variable selling expenses	$3.70
Relevant/Variable Cost Per Unit	$27.10
Unit Selling Price	$60.00
Less: Variable Cost per unit (Relevant Cost)	$27.10
Contribution margin per unit	$32.90
Financial advantage (disadvantage) of investing an additional $120,000 in fixed selling expenses
	$$
Incremental Contribution Margin (87,000 Units x Increase 20% x $32.90)	$572,460
Less: Increase in Fixed Selling Expenses	$120,000
Financial advantage of investing an additional $120,000 in fixed selling expenses	$452,460

Part 1(b) – Yes, the additional investment would be justified, since it will increase the profit.

Part 2 – the break-even price per unit on this order

Particulars	Amount (in US$)
Variable cost of production per unit:
Direct materials price unit	$8.50
Direct labor	$12.00
Variable manufacturing overhead	$2.90
Variable selling expense (associated with order)	$2.40
Import duty	$2.70
Total cost per unit	$28.50
Fixed Costs (Import License Costs)	$15,660.00
Break even selling price per unit ($15,660 + 17,400 Units x $28.50) / 17,400 Units)	$29.40

Part 3 –unit cost figure that is relevant for setting a minimum selling price

700 Daks on hand having irregularities and considered as “second”, so the variable manufacturing costs that would be incurred in making a unit are now IRRELEVANT as these are now sunk cost.

Fixed Costs are also treated as SUNK COST and IRRELEVANT since it will not change.

The unit cost that is relevant for setting a minimum transfer price is the variable selling expenses of $3.70 per unit.

4(a)	Unit Sales of Daks for 2 months (87,000 Daks * 2/12)	14500 Units
	Current Contribution Margin Per Unit (Refer part 1)	$32.90
	Total amount of contribution margin foregone	$477,050
4(b)	Fixed Manufacturing Overhead Per Month ($696,000 / 12)	$58,000
	Total fixed manufacturing overhead costs avoided (58,000*2*60%)	$69,600
	Fixed Selling Expense per month ($304,500 / 12)	$25,375
	Total fixed selling expenses that can be avoided ($25,375*2months*20%)	$10,150
	Total fixed costs avoided if plant is closed for 2 months	$79,750

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you

Pls ask separate question for other parts problems