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 103,200 units per year is: Direct materials $ 1.80 Direct labor $ 3.00 Variable manufacturing overhead $ 0.60 Fixed manufacturing overhead $ 3.95 Variable selling and administrative expenses $ 1.50 Fixed selling and administrative expenses $ 2.00 The normal selling price is $19.00 per unit. The company’s capacity is 132,000 units per year. An order has been received from a mail-order house for 2,400 units at a special price of $16.00 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

A. Only variable cost should be considered because that is a relevant cost. Fixed cost is irrelevant because as stated in the question special offer will not affect the fixed cost.

Particulars		Amount ($)
Selling Price per unit		16
Less: variable cost per unit
Direct Material	1.8
Direct Labour	3
Variable Manufacturing Overhead	0.6
Variable Selling & Administrative Expenses	1.5	6.9
Contribution Margin Per unit (A)		9.1
No of units (B)		2400
Total Contribution (A*B)		21840

Since the special offer will result in increase of contribution of $ 21840. Financial advantage to accept the offer is $ 21840

B. Only variable cost shall be considered because fixed cost is irrelevant. So, unit cost shall be the variable cost . Minimum Selling Price = 6.9 per unit (i.e. variable cost as calculated above)