The following information relates to a product produced by Ashland Company: Dire
ID: 2478992 • Letter: T
Question
The following information relates to a product produced by Ashland Company:
Direct materials
$
10.90
Direct labor
7.90
Variable overhead
6.90
Fixed overhead
8.90
Unit cost
$
34.60
Fixed selling costs are $1,900,000 per year. Variable selling costs of $4.90 per unit sold are added to cover the transportation cost. Although production capacity is 500,000 units per year, Ashland expects to produce only 400,000 units next year. The product normally sells for $49.00 each. A customer has offered to buy 60,900 units for $32.70 each. The customer will pay the transportation charge on the units purchased. If Ashland accepts the special order, the effect on income would be a:
Direct materials
$
10.90
Direct labor
7.90
Variable overhead
6.90
Fixed overhead
8.90
Unit cost
$
34.60
Explanation / Answer
Answer:
The question is related to the decision making where to accept or reject the special order and what will be the impact on the companies earnings if order is accept or reject.
In this type of questions, special attention should be given on the capacity of the company to produce the product.
If company has idle capacity, as in the question the company has idle capacity of production 100,000 Units, the decision is taken on the basis of variable cost associated with the production of special order units.
Fixed Costs are treated as SUNK Cost and has play no role in decision making because fixed costs are past cost which have already been incurred. Whether company accept or reject the special order, fixed cost will remain unchanged.
In the question Customer of special order will pay the transportation charges on the units purchased. Hence there will be no variable selling costs of $4.90 per unit incurred to cover the transportation charges.
Calculation of Relevant Cost for making special order units
Direct Material (60,900 Units x $10.90)
$663,810
Direct Labor (60,900*7.90)
$481,110
Variable Overheads (60,900*6.90)
$420,210
Total Relevant Cost
$1,565,130
Sales Value (60,900*32.70)
$1,991,430
Profit from Special Order (Sales – total relevant cost)
$426,300
If Ashland accepts the special order, the effect on income would be a Increase in Profit by $426,300
Direct Material (60,900 Units x $10.90)
$663,810
Direct Labor (60,900*7.90)
$481,110
Variable Overheads (60,900*6.90)
$420,210
Total Relevant Cost
$1,565,130
Sales Value (60,900*32.70)
$1,991,430
Profit from Special Order (Sales – total relevant cost)
$426,300
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