Special Order: High-Low Cost Estimation SafeRide, Inc. produces air bag systems

Question

Special Order: High-Low Cost Estimation SafeRide, Inc. produces air bag systems that it sells to North American automobile manufacturers. Although the company has a capacity of 300,000 units per year, it is currently producing at an annual rate of 180,000 units. SafeRide, Inc. has received an order from a German manufacturer to purchase 60,000 units at $9.00 each. Budgeted costs for 180,000 and 240,000 units are as follows: 180,000 Units 240,000 Units Manufacturing costs Direct materials $ 450,000 $ 600,000 Direct labor 315,000 420,000 Factory overhead 1,215,000 1,260,000 Total 1,980,000 2,280,000 Selling and administrative 765,000 780,000 Total $ 2,745,000 $ 3,060,000 Costs per unit Manufacturing $ 11.00 $ 9.50 Selling and administrative 4.25 3.25 Total $ 15.25 $ 12.75 Sales to North American manufacturers are priced at $20 per unit, but the sales manager believes the company should aggressively seek the German business even if it results in a loss of $3.75 per unit. She believes obtaining this order would open up several new markets for the company's product. The general manager commented that the company cannot tighten its belt to absorb the $225,000 loss ($3.75 × 60,000) it would incur if the order is accepted. (a) Calculate the net benefit (cost) of accepting the order from the German business. $Answer 225,000 Correct (b) Calculate the net benefit (cost) of accepting the order from the German business, assuming the company is operating at full capacity. $Answer 975,000 Incorrect

Explanation / Answer

Seggregation of semi-variable overheads:

Let V be the variable cost per unit, and F be the fixed cost.

Factory overheads: 180,000V + F = 1,215,000, and 240,000V + F = 1,260,000

V = $ 0.75 per unit and F = $ 1,080,000

Selling and administrative overheads:

180,000V + F = 765,000, and 240,000V + F = 780,000

V = $ 0.25 per unit and F = $ 720,000

a. Net benefit or cost of accepting the German order:

b. If the company is operating at full capacity:

Loss of contribution margin from regular North American orders: ( $ 20 - $ 5.25) x 60,000 = $ 885,000

Contribution margin from German order = ( $ 9 - $ 5.25) x 60,000 = $ 225,000

Net cost of accepting the German order = $ 885,000 - $ 225,000 = $ 660,000

Reject special order Accept special order Net benefit Sales $ 3,600,000 $ 4,140,000 Variable costs $ 945,000 $ 1,260,000 Contribution margin $ 2,655,000 $ 2,880,000 Fixed costs Manufacturing 1,080,000 1,080,000 Selling and administrative 720,000 720,000 Total fixed costs $1,800,000 $1,800,000 Net operating income 855,000 1,080,000 $ 225,000

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