Brief Exercise 23-3 In Harley Company, it costs $31 per unit ($18 variable and $
ID: 2482309 • Letter: B
Question
Brief Exercise 23-3 In Harley Company, it costs $31 per unit ($18 variable and $13 fixed) to make a product that normally sells for $49. A foreign wholesaler offers to buy 3,560 units at $26 each. Harley will incur special shipping costs of $1 per unit. Assuming that Harley has excess operating capacity. Indicate the net income (loss) Harley would realize by accepting the special order. (If an amount reduces the net income for Increase (Decrease) column then enter with a negative sign preceding the number e.g. -15,000 or parenthesis, e.g. (15,000). Enter all other amounts in all other columns as positive and subtract where necessary.) Reject Order Accept Order Net Income Increase (Decrease) Revenues $ Costs—Manufacturing Shipping Net income/(loss) $ The special order should be accepted .Explanation / Answer
Solution:
In case of excess operating capacity, company can utilize their excess capacity by making some more product at only variable cost. because fixed cost will remain constant irrespective of the output level. Excess Operating capacity can be converted into profit if it is utilized in a right manner.
Since the company’s present variable cost for making a product is = $18 per unit
The company will incur only $18 per unit for making one unit of product.
If special order is accepted shipping cost will be $1 per unit
Hence the total variable cost associated with special order will be = $18 + $1 = $19 per unit
Hence the price offered for special order = $26
Contribution Margin Per unit of special order = selling price – variable cost = $26 - $19 = $7 per unit
Hence if the company accept order, per unit contribution / net income will be increased by $7 per unit.
Total Incremental income due to accepting the special order = $7 x 3,560 Units = $24,920
Fixed cost is irrelevant for the decision making because fixed cost in totality will remain same whether company accept offer or reject offer.
Hence, The special order should be accepted because it will increase the net income of the company by $24,920
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