Delta Company produces a single product. The cost of producing and selling a sin
ID: 2452568 • Letter: D
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:
The normal selling price is $26 per unit. The company’s capacity is 110,400 units per year. An order has been received from a mail-order house for 1,800 units at a special price of $23.00 per unit. This order would not affect regular sales.
If the order is accepted, by how much will annual profits be increased or decreased? (The order will not change the company’s total fixed costs.)
Assume the company has 500 units of this product left over from last year 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? (Round your answer to 2 decimal places.)
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:
Explanation / Answer
Solution 1.
Step 1
The Total Variable Cost statement of the company is presented as follows:
The Total Fixed Cost statement of the company is presented as follows:
Total Cost per unit = Fixed Cost per unit (A)+Variable cost per unit (B)
= $ 8.20+ $ 5.55
= $ 13.75 per unit.
Step 2
Total Fixed cost is always calculated at normal activity level.
Normal Activity level = 88,800 units
Total Fixed Cost = Fixed Cost per unit x Noraml capacity
= $ 5.55 x 88,800
= $ 492,840.00
Step 3
Contribution per unit = Selling price per unit-Variable cost per unit
= $ 26.00 - $ 8.20
= $ 17.80 per unit
At regular sales, at present, producing 88,800 units in normal capacity.
If additional 1,800 units are accepted, the total production will be as follows:
Total production after additional order = Current production+Additional production
= 88,800+1,800
= 90,600 units
As we can find, 90,600 units are well within the maximum capacity of the company that is 110,400.
So, production capacity wise there is no constraint.
The offer is accepted over and above the normal capacity of the company. So, the Fixed costs of the company are already recovered. Additional sales over and above normal capacity will only increase the profits if it recovers the variable costs and gives profits per unit more than the profits per unit as per original capacity.
New profit per unit at offer price = Offer selling price-Total variable cost per unit
= $ 23.00 - $ 8.20
= $ 14.80 per unit
So, we can find that profits per unit have increased. Total increase in profits is calculated as follows:
Increase in profits = (Profit as per offer - Profit per unit as per normal capacity) x Offer units
= ($ 14.80 - $ 12.25) x 1,800
= $ 4,590
So, by accepting the offer, the profits of the company will increase by $ 4,590
Solution 2.
An organization should sell a product at reduced prices only if at least its variable cost are recovered. Fixed costs are fixed at normal capacity level and they do not change with change in capacity. So, fixed costs are not relevant in determining minimum sales price.
So, relevant cost for selling 500 inferior units is total varibale cost which is $ 8.20 per unit.
Direct materials $ 2.30 Direct labor $ 3.00 Variable manufacturing overhead $ 0.90 Variable selling and administrative expenses $ 2.00 Total Variable cost per unit (A) $ 8.20Related Questions
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