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 87,600 units per year is:

Direct materials	$	2.50
Direct labor	$	4.00
Variable manufacturing overhead	$	0.80
Fixed manufacturing overhead	$	3.95
Variable selling and administrative expenses	$	1.90
Fixed selling and administrative expenses	$	3.00

The normal selling price is $25.00 per unit. The company’s capacity is 118,800 units per year. An order has been received from a mail-order house for 2,600 units at a special price of $22.00 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?

Answer 1

1.

Analysis of special order

Sales revenue (2,600 x 22)	57,200
Costs:
Direct material (2,600 x 2.50)	- 6,500
Direct labor (2,600 x 4)	- 10,400
Variable manufacturing overhead (2,600 x 0.80)	- 2,080
Variable selling and administrative expenses (2,600 x 1.90)	- 4,940
Net income	$33,280

Fixed manufacturing overheads and fixed selling and administrative expenses are not relevant in deciding whether to accept or reject the special order since these will not change due to the acceptance of the special order.

Financial advantage of accepting the special order = $33,280

2.

The relevant unit cost for establishing the minimum selling price of the defective units is the variable selling and administrative expense.

Relevant unit cost = $1.90