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 $ 1.60

Direct labor $ 2.00

Variable manufacturing overhead $ 1.00

Fixed manufacturing overhead $ 4.55

Variable selling and administrative expenses $ 1.40

Fixed selling and administrative expenses $ 1.00

The normal selling price is $21.00 per unit. The company’s capacity is 108,000 units per year. An order has been received from a mail-order house for 1,600 units at a special price of $18.00 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

Part 1

The financial advantage (disadvantage) is computed as follows

	Per unit	1600 units
Incremental sales	18	28800
Incremental costs:
Direct materials	1.60	2560
Direct labor	2.00	3200
Variable manufacturing overhead	1.00	1600
Variable selling and administrative expenses	1.40	2240
Total incremental costs	6	9600
Financial advantage of accepting the special order	12	19200

Financial advantage $19200

(The fixed costs are not relevant to the decision because they will be incurred regardless of whether the special order is accepted or rejected.)

Part 2

Relevant cost per unit = $1.40

(The relevant cost is $1.40 (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.)