For The Ages Inc. produces solid-oak umbrella stands. Each stand is handmade and hand finished using the finest materials available. The firm has been operating at capacity (2,000 stands per year) for the past three years. Based on this capacity of operations, the firm's costs per stand are as follows:
All selling and administrative expenses incurred by the firm are fixed. The average selling price of stands is $230. Recently, a large retailer approached Bill Wood, the president of For the Ages, about supplying three special stands to give as gifts to CEOs of key suppliers. Wood estimates that the following per-unit costs would be incurred to make the three stands:
|Total direct costs||$690|
To accept the special order, the firm would have to sacrifice production of 20 regular units.
a. Identify all relevant costs that Wood should consider in deciding whether to accept the special order.
|Normal sales price||$_____|
|Lost contribution margin||$_____|
b. Assume the retailer offers to pay For the Ages a total of $3,800 for the three stands. How would accepting this offer affect For the Ages' pre-tax income?
_____ Decrease/ Increase Item Pre-tax Income by $_____
The cost which increases or decreases due to accepting or rejecting a proposal is called a relevant cost. The cost which is not affected by decision-making is called an irrelevant cost. Irrelevant costs are not considered for project evaluation.
Answer and Explanation:
Solve requirement (a) and (b) as follows: -
|a. Evaluation of special order|
|Normal sales price ($230 x 20)||$4,600|
|Less: Variable costs ($50 x 20)||-$1,000|
|Lost contribution margin||$3,600|
|Production costs ($690 x 3)||$2,070|
|b. Computation for effect on net pre-tax income|
|Less: Relevant production cost||-$5,670|
|Net loss in pre-tax income||-$1,870|
Learn more about this topic:
from Accounting 301: Applied Managerial AccountingChapter 9 / Lesson 12