Question

Adams Company, which produces and sells a small digital clock, bases its pricing strategy on a 25 percent markup on total cost. Based on annual production costs for 12,000 units of product, computations for the sales price per clock follow:

Unit-level costs Fixed costs Total cost (a) Markup (a * 0.25) Total sales (b) Sales price per unit (b = 12,000) $228,000 60,000 288,000 72,000 $360,000 30

1. Adams has excess capacity and receives a special order for 5,000 clocks for $22 each. Calculate the contribution margin per unit. Based on this, should Adams accept the special order?

2. Prepare a contribution margin income statement for the special order.

Answer 1

Working :

Variable cost varies with number of units produced or sold so it is always a relevant cost while making decision as to acceptance of offer as same is an incremental cost .(in the given problem ,unit level cost is relevant to decision making)

Unit level cost per unit= 228000/12000 = $ 19 per unit

Fixed cost remains constant within a relevant range and does not varies with output thus it is irrelevant to decision making.(in the given problem ,Fixed cost is irrelevant as same will be incurred whether offer is accepted or not)

a)

Contribution per unit = special offer price - unit level cost

                         = 22 - 19

                          = $ 3 per unit

Since contribution per unit is positive ,,special order should be accepted.

b)

ADAMS COMPANY CONTRIBUTION MARGIN INCOME STATEMENT
Revenue (5000*22)	110000
less:Unit level cost (5000*19)	(95000)
Total contribution margin	15000