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 99,600 units per year is:

Direct materials	$	1.60
Direct labor	$	3.00
Variable manufacturing overhead	$	0.50
Fixed manufacturing overhead	$	5.15
Variable selling and administrative expenses	$	2.00
Fixed selling and administrative expenses	$	2.00

The normal selling price is $19.00 per unit. The company’s capacity is 134,400 units per year. An order has been received from a mail-order house for 2,900 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

Answer for 1)

Here the fixed manufacturing costs doesn't change it can be recovered from regular sales.Hence the special order may be considered as net of fixed cost.hence only direct material, direct labour, variable manufacturing and variable selling and administration overheads are considered as cost.

Financial advantage or disadvantage of accepting the special order:2900units×[$16-$(1.6+3+0.5+2)]

=$25810

Answer for 2)

Minimum price will be also be $2 I.e variable selling and administration overhead.As such units are brought forward from the previous year all variable costs are sunk and fixed costs are absorbed by ordinary units.