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 100,800 units per year is:

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 100,800 units per year is:

Direct materials	$	1.50
Direct labor	$	3.00
Variable manufacturing overhead	$	0.80
Fixed manufacturing overhead	$	4.35
Variable selling and administrative expenses	$	1.40
Fixed selling and administrative expenses	$	2.00

The normal selling price is $18.00 per unit. The company’s capacity is 130,800 units per year. An order has been received from a mail-order house for 2,500 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?

Explanation

The financial advantage is computed as follows:

	Per Unit			2,500 Units
Incremental sales	$	15.00		$	37,500
Incremental costs:
Direct materials		1.50			3,750
Direct labor		3.00			7,500
Variable manufacturing overhead		.80			2,000
Variable selling and administrative		1.40			3,500
Total incremental costs	$	6.70			16,750
Financial advantage of accepting the special order		8.30			20,750

The fixed costs are not relevant to the decision because they will be incurred regardless of whether the special order is accepted or rejected.

2.

The relevant cost is $1.40 (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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