Question

Peter company produces a product with the following unit cost : Direct Material Direct Labour Variable overhead Fixed Overhead Unit cost S 2.75 1.25 4.00 2.50 10.50 Fixed selling costs are $600.000 per year and variable selling costsare $1.50 per unit sol Production capacity is 500.000 units per year. However, the company expects to produc only 300,000 units per year. The product normally sells for $15 each. A customer has offered to buy 150.000 units for $10. The units would be sold in an area outside the market area currently served REQUIRED 1. Calculate the incremental cost per unit associated with the special order. 2. What is the total incremental cost associated with special order? 3. What be the effect on income if the firm produces the special order? By how much will it increase or decrease the income?

Answer 1

Part a

Calculation of Incremental cost per unit associated with special order:

$ 2.75 Direct Material Direct Labour Variable Overhead Fixed Overhead (Refer Note] Unit Cost 1.25 4.00 0.00 8.00 Unit Cost Fixed Selling Cost [Refer Note] Variable Selling Cost 8.00 0.00 1.50 Total Incremental Cost per Unit 9.50

Note: For Calculation of Incremental cost per unit for special order, we would ignore fixed cost related to production because fixed overhead and cost would not change with the unit of production, also change in production level does not impact the Fixed Overhead and Fixed Selling Cost as they would surely incure whether we produce or process the special order or not.

Answer: Total Incremental Cost per Unit = $9.50

Part b

Total Incremental Cost associates with special order = Total Incremental Cost per Unit * Unit of Special Order = $9.50 * 150,000 = $1,425,000

Total Incremental Cost associated with special order is $1,425,000

Part c

The income of the firm produces the special order would increase because Price offered by customer i.e. $10 is higher than incremental cost associated with special order i.e. $9.50 per unit.

Particulars	Working	$
Total Revenue from Special order	150,000 * $10 per Unit	1,500,000
Incremental Cost associated with special order	150,000 * $9.50 per unit	1,425,000
Net Income	[1,500,000 - 1,425,000]	75,000

The income will increase by $75,000.