Question

Exercise 12-9 Special Order Decision [LO12-4]

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	$	2.30
Direct labor	$	3.00
Variable manufacturing overhead	$	0.70
Fixed manufacturing overhead	$	4.75
Variable selling and administrative expenses	$	2.00
Fixed selling and administrative expenses	$	2.00

The normal selling price is $22.00 per unit. The company’s capacity is 133,200 units per year. An order has been received from a mail-order house for 2,500 units at a special price of $19.00 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. The company does not expect the selling of these inferior units to have any effect on the sales of its current model. What unit cost is relevant for establishing a minimum selling price for these units?

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. The company does not expect the selling of these inferior units to have any effect on the sales of its current model. What unit cost is relevant for establishing a minimum selling price for these units? (Round your answer to 2 decimal places.)

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	Relevant cost per unit

Answer 1

Relevant cost per unit for special order:

= $2.30 + $3 + $0.70 + $2

= $8

The special order selling price is more than the relevant cost per unit. There will be financial advantage from this special order,

1)

Financial advantage = ($19 - $8) X 2,500

= $27,500

2)

All the cost incurred for 1,000 units which are inferior to the current model are sunk costs.

$2 Variable selling and administrative expense should be incurred for selling the 1,000 inferior units.

Relevant cost = $2