King Manufacturing produces a single product. The cost of producing and selling
ID: 2587047 • Letter: K
Question
King Manufacturing produces a single product. The cost of producing and selling a single unit of this product at the company's normal activity level of 40,000 units per month is as follows:
Direct materials $38.80
Direct labor (variable cost) $9.70
Variable manufacturing overhead $2.30
Fixed manufacturing overhead $18.10
Variable selling & administrative expense $1.70
Fixed selling & administrative expense $8.80
Normal selling price per unit $85.10
An order has been received from an outside customer for 3,000 units to be delivered this month at a special discounted price. This order would have no effect on the company's normal sales and would not change the total amount of the company's fixed costs. The variable selling and administrative expense would be $0.20 less per unit on this order than on normal sales.
Required:
(a) Suppose the company has ample idle capacity to produce the units required by the overseas customer and the special discounted price on the special order is $75.30 per unit. By how much would this special order increase (decrease) the company's net operating income for the month?
(b) Suppose the company is already operating at capacity when the special order is received from the overseas customer. What would be the minimum acceptable price per unit for the special order?
(c) Suppose the company does not have enough idle capacity to produce all of the units for the overseas customer and accepting the special order would require cutting back on production of 1,000 units for regular customers. What would be the minimum acceptable price per unit for the special order?
(d) What are some of the issues other than capacity that King Manufacturing should consider in determining the price per unit for the special order? Discuss at least 2 issues in detail.
Explanation / Answer
a) Calculating Profit/Loss for normal production without including overseas order
From the above the normal profit margin per unit is $5.7
Calculating profit at 43000 units including overseas order of 3000 units
Sales of 40,000 units as per above table = 3,404,000
Sale of 3000 units at $ 75.30 = 225,900
Total Sales for 43000 units = 3,629,900 ...... (A)
Total variable cost per unit $ 52.5 (from above) - $ 0.20 = $ 52.3
Total Variable Cost for 43000 units = 2,248,900 ........ (B)
It is given that there is no change in the total Fixed Cost
Therefore total Fixed cost from above table = 1,076,000 ...... (C)
Profit on Sale of 43000 units is (A-B-C) = 305,000
Therefore, there is an increase of $ 77,000 profit per month by executing the overseas order.
(b) Minimum acceptable price per unit if the Company is already operating at full capacity
If the Company is already running at full capacity, the Fixed Overhead cost also increases with increase in sales. So, to maintain the same level of profit the selling price cannot be reduced. Since it is given that $ 0.2 variable overhead cost would be reduced with increased production, the selling price can be reduced by the same amount and therefore the minimum selling price for overseas order would be $ 84.9
(c) Minimum Price for special order if the regular sales decreased by 1000 units
The profit margin in regual sales per unit is $ 5.7 from the above table
So, if 1000 units production is reduced the profit will be reduced by $ 5700
The price of the special order should be increased to accomodate this drop in profit
Therefore the increase in special order price per unit = 5700/3000 = 1.9
Therefore the minimum special price per unit should be = 75.3 + 1.9 = $ 77.2
(d) Issues to be considered in determining the price per unit of special order
i. Fixed Overhead Cost: It should be seen that the discounted price should be more than the savings in the Fixed Overhead cost. The per unit Variable cost will generall remain same even at increased production, so the only possiblity for reducing the price without decrease in profit would be the savings in Fixed Overheads. So once the unit is running at full capacity, no price discount cab be given since the Fixed Overheads will also increase
ii. Utilising the excess materials or man power on increased produciton: If the special order can be taken by utlising the existing surplus man power or material cost etc., the price of special order can be reduced to the extent of savings in the per unit variable cost of produciton.
Particulars Per Unit For 40000 units Sales - (A) 85.10 3,404,000 Material Cost 38.80 1,552,000 Direct Labor 9.70 388,000 Variable Manufacturing Overhead 2.3 92,000 Variable Selling & Admin Exp 1.7 68,000 Total Variable Cost (B) 52.5 2,100,000 Contribution (C) = (A - B) 32.60 1,304,000 Fixed Manufacturing Exp 18.1 724,000 Fixed Selling & Admin overhead 8.8 352,000 Total Fixed Overhead Cost (D) 26.9 1,076,000 Profit (E) = (C) - (D) 5.7 228,000Related Questions
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