Question

III eTextbook: Survey of Accou TT Search Annotations Accessibility Bookmark 2 Rubber Meets the Road Company has capacity to produce 250,000 tires. Rubber Meets the Road presently produces and sells 100,000 tires for the North American market at a price of $20 per tire. Rubber Meets the Road is evaluating a special order from a South American automobile company, Cruising Motors. Cruising Motors is offering to buy 20,000 tires for $10 per tire. Rubber Meets the Road's accounting system indicates that the total cost per tire is as follows: Direct materials Direct labor Factory overhead (45% variable) Selling and administrative expenses (30% variable) Total $ 5.00 2.50 200 1.50 $11.00 Rubber Meets the Road pays a sales commission equal to 2% of the selling price on North American orders, which is included in the variable portion of the selling and administrative expenses. However, this special order would not have a sales commission. If the order was accepted, the tires would be shipped overseas for an additional shipping cost of $0.75 per tire. In addition, Cruising has made the order conditional on Rubber Meets the Road receiving a Brazilian safety certification. Cruising estimates that this certification would cost Rubber Meets the Road $10,000. a Prepare a differential analysis report for the proposed sale to Cruising Motors. ANSWER + b. What is the minimum price per unit that would be financially acceptable to Rubber Meets the Road?

Answer 1

Solution

Rubber Meets the Road Company

a. Differential analysis on whether to reject (Alternative 1) or accept (Alternative 2) the Special order from Cruising Motors:

Differential Analysis Reject Order (Alt 1) or Accept Order (Alt 2) Reject Order (Alternative 1) $0 Accept Order (Alternative 2) $200,000 Differential Effect on Income (Alternative 2) $200,000 $0 $0 ($100,000) ($50,000) ($100,000) ($50,000) Revenues Costs: Direct Material Direct Labor Variable Factory Overhead Variable selling and admin. Expenses Shipping Costs Certification costs Income/(loss) $0 ($18,000) ($18,000) $0 $0 $0 $0 ($1,000) ($15,000) ($10,000) $6,000 ($1,000) ($15,000) ($10,000) $6,000

The differential analysis of rejecting or accepting the special order indicates an increase net operating income by $6,000.

Therefore, the order from Cruising Motors should be accepted.

Computations:

1. Revenues –

Revenues on accepting the order = $10 x 20,000 units = $200,000

2. Costs –

Direct materials = $5 x 20,000 = $100,000

Direct labor = $2.50 x 20,000 = $50,000

Variable factory overhead = ($2 x 45%) x 20,000 = $18,000

Variable selling and admin. Expenses –

($1.50 x 30%) = $0.45

Less: unit sales commission = 2% x $20 = $0.40

Variable selling and admin expenses per unit = $0.05

Variable selling and admin expenses = $0.05 x 20,000 = $1,000

Shipping costs = $0.75 x 20,000 = $15,000

Certification costs = $10,000

a. Determination of the minimum price that would be financially acceptable to Rubber Meets the Road:

Any price above the unit variable cost would earn a positive contribution margin. Hence, the minimum price that would be acceptable must be a $1 above the total unit variable cost and the relevant fixed cost relating to certification.

Total unit variable cost:

Direct material      $5

Direct labor           $2.50

Variable factory overhead            $0.90

Variable selling and admin           $0.05

Shipping costs                              0.75

Total variable costs                      $9.20

Certification costs                        $0.50   ($10,000/20,000 units)

Total relevant cost per unit           $9.70

The minimum acceptable price per unit = special selling price per unit – (incremental profit/units for special order)

= $10 – ($6,000/20,000) = $9.70

Hence, the minimum price that is financially acceptable = $9.70 per unit