3) Woodson Corporation provided the following information regarding its only pro
ID: 2580722 • Letter: 3
Question
3) Woodson Corporation provided the following information regarding its only product: Sale price per unit Direct materials used Direct labor incurred Variable manufacturing overhead Variable selling and administrative expenses Fixed manufacturing overhead Fixed selling and administrative expenses Units produced and sold $65.00 $160,000 $185,000 $120,000 $70,000 $65,000 $12,000 10,000 Assume no beginning inventory Assuming there is excess capacity, what would be the effect on operating income of accepting a s order for 1,200 units at a sale price of $60 per product assuming additional fixed manufacturing overhead costs of $5,000 is incurred? (NOTE: Assume regular sales are not affected by the special order.) (5 points)Explanation / Answer
Solution:
This is a question of relevant cost and irrelevant cost related to Special Order. It means company has idle capacity and can produce and sold any number of units. In such situation only relevant cost will be considered for decision making.
Relevant Cost is the cost which will incur in future and different under each alternative course of action. It means the cost which will incur in making the special order units are the relevant cost. The following costs are considered as relevant cost:
- Direct material cost
- direct labor cost
- variable manufacturing overhead
- variable selling and administrative expenses
The above costs are the variable cost which will vary with the production volume. Hence these costs have both the characteristic of relevant cost i.e. it is a future cost and different under each alternative course of action.
Additional Cost directly associated with the Special Order is also relevant cost because if company accept order it will incur otherwise it will not incur.
Irrelevant cost is the cost which do not play any role in decision making. Irrelevant Cost is the SUNK Cost which has already been incurred and does not change whether company accept the order or reject the order. All other fixed costs are irrelevant cost in the question except additional fixed manufacturing costs. Since these fixed costs are already been incurred and does not change in any case whether company select or reject the special order.
Calculation of Profitability from Special Order
Special Order
Unit Selling Price (A)
$60.00
Unit Variable Cost:
Direct material cost (160,000/10,000)
$16.00
Direct labor cost (185,000 / 10,000)
$18.50
Variable Manufacturing overhead (120,000 / 10,000)
$12.00
Variable Selling and administrative expense (70,000 / 10,000)
$7.00
Variable Cost per unit (B)
$53.50
Contribution Margin per unit (A-B)
$6.50
Units of Special Order
1,200 Units
Total Contribution Margin From Special Order (1200 Units x $6.50)
$7,800
Less: Additional Fixed manufacturing overhead
(directly associated with the special order)
-$5,000
Increase in Operating Income
$2,800
The effect on operating income of accepting a special order would be INCREASE IN OPERATING INCOME $2,800
Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you
Special Order
Unit Selling Price (A)
$60.00
Unit Variable Cost:
Direct material cost (160,000/10,000)
$16.00
Direct labor cost (185,000 / 10,000)
$18.50
Variable Manufacturing overhead (120,000 / 10,000)
$12.00
Variable Selling and administrative expense (70,000 / 10,000)
$7.00
Variable Cost per unit (B)
$53.50
Contribution Margin per unit (A-B)
$6.50
Units of Special Order
1,200 Units
Total Contribution Margin From Special Order (1200 Units x $6.50)
$7,800
Less: Additional Fixed manufacturing overhead
(directly associated with the special order)
-$5,000
Increase in Operating Income
$2,800
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