Question

Special Order: High-Low Cost Estimation
SafeRide, Inc. produces air bag systems that it sells to North American automobile manufacturers. Although the company has a capacity of 300,000 units per year, it is currently producing at an annual rate of 180,000 units. SafeRide, Inc. has received an order from a German manufacturer to purchase 60,000 units at $7.00 each. Budgeted costs for 180,000 and 240,000 units are as follows:

	180,000 Units	240,000 Units
Manufacturing costs
Direct materials	$450,000	$600,000
Direct labor	315,000	420,000
Factory overhead	1,215,000	1,260,000
Total	1,980,000	2,280,000
Selling and administrative	765,000	780,000
Total	$2,745,000	$3,060,000
Costs per unit
Manufacturing	$11.00	$9.50
Selling and administrative	4.25	3.25
Total	$15.25	$12.75

Sales to North American manufacturers are priced at $25 per unit, but the sales manager believes the company should aggressively seek the German business even if it results in a loss of $5.75 per unit. She believes obtaining this order would open up several new markets for the company's product. The general manager commented that the company cannot tighten its belt to absorb the $345,000 loss ($5.75 × 60,000) it would incur if the order is accepted.

(a) Calculate the net advantage (disadvantage) of accepting the order from the German business.

Use a negative sign with your answer to indicate a net disadvantage, if applicable.

$Answer

(b) Calculate the net advantage (disadvantage) of accepting the order from the German business, assuming the company is operating at full capacity.

Use a negative sign with your answer to indicate a net disadvantage, if applicable.

$Answer

Answer 1

Workings:

Variable Costs:

Direct Materials ($450,000/180,000) = $ 2.50 per unit

Direct Labor ($315,000/180,000) = $1.75 per unit

Factory Overhead costs:

High Low Difference

Units 240,000 180,000 60,000

Cost $1,260,000 $1,215,000 45,000

Variable cost per unit = 45,000/60,000 = $0.75 per unit

Fixed cost = $1,260,000 - (240,000 x 0.75) = $1,080,000

Selling and administrative costs:

High Low Difference

Units 240,000 180,000 60,000

Cost $780,000 $765,000 15,000

Variable cost per unit = 15,000/60,000 = $0.25 per unit

Fixed cost = $780,000 - (240,000 x $0.25) = $720,000

Contribution Current Special Order

Selling price per unit $25 $7

Variable cost per unit:

Direct materials $2.50 $2.50

Direct labor $1.75 $1.75

Variable overhead $0.75 $0.75

Variable selling exp $0.25 $0.25

Contribution per unit $19.75 $1.75

a) Net advantage of accepting special order = $1.75 x 60,000 = $105,000

b) Net disadvantage = - $ 1,080,000

Contribution lost of regular sales ($19.75 x 60,000) = $1,185,000

Income from special order = $105,000

Net Loss = $1,185,000 - $105,000 = - $1,080,000