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For The Ages Inc. produces solid-oak umbrella stands. Each stand is handmade and hand finished...

Question:

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:

Direct material $50
Direct labor 40
Variable 10
Fixed overhead 30
Total cost $130

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:

Direct material $250
Direct labor 350
Variable overhead 90
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 $_____
Variable costs _____
Lost contribution margin $_____
Production costs _____
Total costs $_____

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 $_____

Relevant Cost:

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
Particulars Amount
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
Total costs $5,670
b. Computation for effect on net pre-tax income
Particulars Amount
Offer Price $3,800
Less: Relevant production cost -$5,670
Net loss in pre-tax income -$1,870


Learn more about this topic:

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Relevant Costs in Eliminating a Product or Segment

from Accounting 301: Applied Managerial Accounting

Chapter 9 / Lesson 12
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