Question

QUESTION 2 Auto Car Excellence (ACE) manufactures high quality engines. The engines are sold to manufacturers who install them in electrical products such as lawn mowers. The company has recently received an invitation to bid on a special order for 20,000 units of one of its most popular engine, Super Auto. ACE's factory plant has a maximum capacity of 80,000 units but it currently manufactures only 40,000 units of the products. Therefore, there will be no additional factory overhead incurred if the special order is accepted. In addition, there will be no marketing costs on the special order. The sales manager of ACE wants to set the bid at RM9 because she is sure that ACE will get the business at that price. Others on executive committee of the firm disagree, saying that ACE would lose money on special order at that price. The committee has prepared the following computation: Level of Production Manufacturing costs: Direct materials Direct labour Factory overhead Total manufacturing costs Cost per unit 40,000 units RM 80,000 120,000 240,000 RM440,000 RM11 60,000 units RM 120,000 180,000 300,000 RM600,000 RMIO Factory overhead consists of both variable and fixed overhead. Required: a. Why does the unit cost decline from RM11 to RM10 when the production level rises from 40,000 units to 60,000 units? Explain and provide computation on how the committee derived the cost per unit. (5 marks) b. Is the sales manager correct? What do you think the bid price should be? Explain and show the relevant cost analysis. (8 marks) c. Discuss FOUR non-financial factors ACE should consider in deciding how much to bid on this special order. (4 marks) d. Assume that ACE is operating at full capacity. What would the opportunity cost be if by accepting special order the company lost sales of 5,000 units to its regular customers? The regular selling price is RM20. (3 marks) Suppose that after ACE accepts the special order, it finds that unexpected production delays will not allow it to supply all 20,000 units from its own plants and meet the promised delivery date. It can provide the same type of engine by purchasing them in bulk from competing firm. The engine would then be labelled with ACE's name to complete the order. ACE does not have enough time to carefully test the competitor's product to determine its quality. What should ACE do? Explain and include ethical viewpoint in your answer. (5 marks) TOTAL: 25 MARKS]

Answer 1

Answer-a:

The cost per unit declined from RM11 to RM10 as the number of units produced increases from 40,000 units to 60,000 units, because the total fixed costs of RM 120,000 get spread over a larger number of units.

Variable cost per unit = (RM300,000 - 240,000) / (60,000 - 40,000) = RM3 per unit

Fixed cost = RM240,000 - (40,000 * RM3) = RM240,000 - RM120,000 = RM120,000

40,000 units 60,000 units RM2 RM2 Level of production Variable cos per unit: Direct materials Direct labours Factory overhead Total variable cost per unit Fixed overhead cost per unit: (120,000/40,000) (120,000/60,000) Cost per unit RM11 RM10

Answer-b:

Yes the sales manager is correct. The total variable cost per unit to produce 20,000 units is RM8. Hence bid price of RM9 is acceptable. Fixed cost is not relevant in this case because ACE has to incur the fixed cost whether the offer is accepted or not. Also there is no opportunity cost because ACE is not utilizing full capacity.

Answer-d:

Regular Special customer order Sales price I RM20 RM9| Variable cost 88 Contribution per unit RM12 RM1

Contribution lost on accepting special order = RM12 - RM1 = RM11

Hence, opportunity cost = 5,000 units * RM11 = RM55,000