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 88,800 units per year is:

Direct materials	$	1.90
Direct labor	$	4.00
Variable manufacturing overhead	$	0.80
Fixed manufacturing overhead	$	3.45
Variable selling and administrative expenses	$	1.90
Fixed selling and administrative expenses	$	3.00

The normal selling price is $20.00 per unit. The company’s capacity is 121,200 units per year. An order has been received from a mail-order house for 2,700 units at a special price of $17.00 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)
Revenue from special order (2,700 units * $17 per unit)	$45,900
Less: Direct materials cost (2,700 units * $1.90 per unit)	($5,130)
Less: Direct labor cost (2,700 units * $4 per unit)	($10,800)
Less: Variable manufacturing overheads (2,700 units * $0.80 per unit)	($2,160)
Less: Variable selling & administrative expenses (2,700 units * $1.90 per unit)	($5,130)
Financial Advantage	$22,680
2)
Due to the total units that were already produced, all the variable costs except variable selling and administrative expenses per unit of $1.90 are sunk costs and also, the fixed costs are irrelevant because the price of units which were left-over have not have any impact due to the change in prices, therefore, the selling and administrative expenses per unit of $1.90 per unit is the relevant for establishing a minimum selling price.