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 92,400 units per year is: Direct materials $ 1.90 Direct labor $ 3.00 Variable manufacturing overhead $ 0.70 Fixed manufacturing overhead $ 5.25 Variable selling and administrative expenses $ 2.00 Fixed selling and administrative expenses $ 2.00 The normal selling price is $25.00 per unit. The company’s capacity is 124,800 units per year. An order has been received from a mail-order house for 2,700 units at a special price of $22.00 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

Answer 1.
Calculation of Increase in Profits
if Special Order is Accepted
Incremental Sales - 2,700 Units X $22		59,400
Incremental Cost:
Direct Material - 2,700 Units X $1.90	5,130
Direct Labor - 2,700 Units X $3	8,100
Variable MOH - 2,700 Units X $0.70	1,890
Variable Selling & Admn. Exp. - 2,700 Units X 2	5,400	20,520
Incremental Profit		38,880
Annual Profits would increased by $38,880.
Fixed Costs are not relevant for decision making, since they are sunk cost because they will be incurred whether special order is accepted or not.
Answer 2.
All the costs incurred in past are sunk cost or not relevant in the decision making. Only the variable selling and adminstration expenses are relevant here.
Relevant Cost per Unit = $2 per Unit (Variable Selling & Adminstration Expenses)