Majestic Company manufactures a product that has the following unit costs: direc

Question

Majestic Company manufactures a product that has the following unit costs: direct materials, $5; direct labor, $7; variable overhead, $3; and fixed overhead, $5. Fixed selling costs are $200,000 per year. Variable selling costs of $1 per unit cover the transportation cost. Although production capacity is 80,000 units per year, the company expects to produce only 65,000 units next year. The product normally sells for $30 each. A customer has offered to buy 10,000 units for $18 each. The customer will pay the transportation charge on the units purchased. Required: What is the incremental cost per unit to Majestic Company for the special order? What is the effect on Majestic's income if the special order is accepted?

Explanation / Answer

a. Computation of incremental cost per unit

(i) Direct Material - $5

(ii) Direct Labour - $7

(iii) Variable Overhead - $3

(iv) Variable selling cost - $0 (The variable selling cost is to cover the transportation cost. Here the transportation cost will be paid by the customer)

Total incremental cost per unit = (i) + (ii) + (iii) + (iv) = $5 + $7 + $3 + $0 = $15

(note: the fixed selling costs and fixed overheads need not be considered as the same will be incurred irrespective of whether or not the current proposal is accepted)

b. effect on Majestic'c income if the project is accepted

Selling Price per unit = $18

Incremental cost per unit = $15

Contribution per unit = $3

No. of units = 10,000

The net income will increase by $30,000 (10,000x$3)

(note: as the production capacity is 80,000 units and the expected production is 65,000 units, accepting the current proposal for 10,000 units will not impact the production capacity)

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