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 103,200 units per year is:

Direct materials	$	2.30
Direct labor	$	3.00
Variable manufacturing overhead	$	0.80
Fixed manufacturing overhead	$	5.15
Variable selling and administrative expenses	$	1.90
Fixed selling and administrative expenses	$	2.00

The normal selling price is $21.00 per unit. The company’s capacity is 130,800 units per year. An order has been received from a mail-order house for 2,300 units at a special price of $18.00 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. The financial advantage of accepting the special order

	Per Unit	For 2,300 Units
Incremental sales	$18.00	$41,400
Incremental Costs:
Direct materials	$2.30	$5,290
Direct labor	$3.00	$6,900
Variable manufacturing overhead	$0.80	$1,840
Variable selling and administrative	$1.90	$4,370
Total incremental costs	$8.00	$18,400
Incremental profits	$10.00	$23,000

“Financial advantage = Annual profits will increase by $23,000”

2. Relevant Cost per unit

The relevant cost per unit is $1.90 (Variable selling and administrative expenses). All other variable costs are sunk costs. The fixed costs are not relevant because they will not change in total