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Our company manufactures and sells calculators for $90 each. A major University has offered us...

Question:

Our company manufactures and sells calculators for $90 each. A major University has offered us $70 per calculator for a one-time order of 500 calculators.

Our costs to manufacture a calculator include:

-direct materials, $25 per unit;

-direct labor, $20 per unit;

-variable factory overhead, $15 per unit; and

-fixed manufacturing overhead, $12 per unit.

Assume that we have excess capacity and the special order will not affect regular sales.

a. What is the change in operating income that would result from accepting this special sales order?

b. Should we accept the special order?

Relevant Costs

Relevant costs are costs which differ across different alternatives or scenarios. Relevant costs are used in comparing outcomes of different scenarios and is useful in decision analysis.

Answer and Explanation:

a. In this scenario, we assume that the relevant costs are the variable costs since fixed costs remain regardless of the number of units produced while variable costs are only incurred when a unit is produced:

Direct materials $25
Direct labor 20
Variable factory overhead 15
Total $60

Below, we determine the change in operating income from accepting the special order:

{eq}\begin{align*} Change\ in\ operating\ income &= (Selling\ Price\ per\ Unit - Relevant\ Variable\ Costs) \times No.\ of\ units \\&= ($70 - $60) \times 500\ units \\&= $10 \times 500\ units \\& = $5,000 \end{align*} {/eq}

The company's operating income is expected to increase by $5,000 from accepting the special order.

b. Yes, the company should accept the special order in this scenario since it is expected to benefit by an increase of $5,000 in operating income.


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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