Demonstration Problem

Chapter 16 – Exercise 5Accept Special Sales Order?

AccountingWhat the Numbers Mean 9e

Problem Definition

• Circuit Masters, Inc., (CMI) is presently operating at 80% of capacity and manufacturing 120,000 units of a patented electronic component. The cost structure of the component is as follows:

Raw materials $ 6.00 per unitDirect labor 6.00 per unitVariable overhead 8.00 per unitFixed overhead $ 480,000 per year

Problem Definition

• An Italian firm has offered to purchase 20,000 of the components at a price of $24 per unit, FOB CMI’s plant. The normal selling price is $32 per component. This special order will not affect any of CMI’s “normal” business. Management calculated that the cost per component is $24, so it is reluctant to accept this special order.

Problem Requirements

a. Show how management came up with a cost of $24 per unit for this component.

b. Evaluate this cost calculation. Explain why it is or is not appropriate.

c. Should the offer from the Italian firm be accepted? Why or why not?

Problem Solution

a. Show how management came up with a cost of $24 per unit for this component.

Calculate the cost per unit of manufacturing 120,000 component parts in the current year.

Cost per unitDirect material

Problem Solution

Cost per unitDirect material $ 6.00

Problem Solution

Given

Cost per unitDirect material $ 6.00Direct labor

Problem Solution

Cost per unitDirect material $ 6.00Direct labor 6.00

Problem Solution

Given

Cost per unitDirect material $ 6.00Direct labor 6.00Variable overhead

Problem Solution

Cost per unitDirect material $ 6.00Direct labor 6.00Variable overhead 8.00

Problem Solution

Given

Cost per unitDirect material $ 6.00Direct labor 6.00Variable overhead 8.00Fixed overhead

Problem Solution

Cost per unitDirect material $ 6.00Direct labor 6.00Variable overhead 8.00Fixed overhead 4.00

Problem Solution

Fixed overhead per unit = Total fixed overhead / Current units produced = $480,000 / 120,000 units

Cost per unitDirect material $ 6.00Direct labor 6.00Variable overhead 8.00Fixed overhead 4.00Cost per unit

Problem Solution

Cost per unitDirect material $ 6.00Direct labor 6.00Variable overhead 8.00Fixed overhead 4.00Cost per unit $24.00

Problem Solution

Cost per unitDirect material $ 6.00Direct labor 6.00Variable overhead 8.00Fixed overhead 4.00Cost per unit $24.00

Problem Solution

Solution: Cost per unit = $24.00

Problem Requirements

a. Show how management came up with a cost of $24 per unit for this component.

b. Evaluate this cost calculation. Explain why it is or is not appropriate.

c. Should the offer from the Italian firm be accepted? Why or why not?

Problem Solution

The calculation includes an inappropriate unitization of fixed costs for decision making purposes. Unless

the additional production of 20,000 units results in a movement to a new

relevant range, total fixed expenses will not change.

Problem Requirements

a. Show how management came up with a cost of $24 per unit for this component.

b. Evaluate this cost calculation. Explain why it is or is not appropriate.

c. Should the offer from the Italian firm be accepted? Why or why not?

Problem Solution

c. Should the offer from the Italian firm be accepted? Why or why not?

Analyze the relevant costs associated with producing an additional 20,000 units by

accepting the special offer of $24 per unit.

Relevant Cost AnalysisSelling price

Problem Solution

Relevant Cost AnalysisSelling price $24.00

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:

Problem Solution

The relevant costs of accepting this special offer are the incremental costs incurred by producing the

additional 20,000 units.

Relevant Cost AnalysisSelling price $24.00Less relevant costs:Direct material

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:Direct material 6.00

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:Direct material 6.00Direct labor

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:Direct material 6.00Direct labor 6.00

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:Direct material 6.00Direct labor 6.00Variable overhead

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:Direct material 6.00Direct labor 6.00Variable overhead 8.00

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:Direct material 6.00Direct labor 6.00Variable overhead 8.00Contribution margin per unit

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:Direct material 6.00Direct labor 6.00Variable overhead 8.00Contribution margin per unit $ 4.00

Problem Solution

Relevant Cost AnalysisSelling price $24.00Less relevant costs:Direct material 6.00Direct labor 6.00Variable overhead 8.00Contribution margin per unit $ 4.00

Problem Solution

Note: Fixed costs are not relevant to this decision!

Problem Solution

The offer should be accepted because it would generate contribution of $4 per

unit or $80,000 total contribution. Since CMI was operating with idle

capacity, and unless a more profitable opportunity were available for the use of the idle capacity, accepting the offer

would increase profits by $80,000.

AccountingWhat the Numbers Mean 9e

David H. MarshallWayne W. McManus

Daniel F. Viele

You should now have a better understanding ofspecial pricing decisions.

Remember that there is a demonstration problem for each chapter that is here for your learning benefit.