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 91,200 units per year is:

Direct materials	$	1.60
Direct labor	$	3.00
Variable manufacturing overhead	$	0.70
Fixed manufacturing overhead	$	4.75
Variable selling and administrative expenses	$	1.90
Fixed selling and administrative expenses	$	2.00

The normal selling price is $18.00 per unit. The company’s capacity is 104,400 units per year. An order has been received from a mail-order house for 1,100 units at a special price of $15.00 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

Part a)

FINANCIAL ADVANTAGE WILL BE OF $8580

	Per unit	1100 units
Incremental sales	$15	$16500
Incremental cost:
Direct material	$1.6	$1760
Direct labour	$3.0	$3300
Variable manufacturing OH	$0.7	$770
Variable selling and administration	$1.9	$2090
Total incremental cost:	$7.2	$7920
Incremental profit	$7.8	$8580

Part 2)

The relevant cost is $1.90 (the variable selling and administrative expenses). All other variable costs are sunk because the units have already been produced. The fixed costs are not relevant because they will not change in total as a consequence of the price charged for the left over units.

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