Demonstration Problem Accounting What the Numbers Mean 6e Demonstration Problem Chapter 16 – Exercise 7 Accept Special Sales Order?

Problem Definition Integrated Circuit, Inc., (ICI) is presently operating at 50% of capacity and manufacturing 50,000 units of a patented electronic component. The cost structure of the component is as follows: Raw materials $ 1.50 per unit Direct labor 1.50 per unit Variable overhead 2.00 per unit Fixed overhead $ 100,000 per year

Problem Definition A Japanese firm has offered to purchase 30,000 of the components at a price of $6 per unit, FOB ICI’s plant. The normal selling price is $8 per component. This special order will not affect any of ICI’s “normal” business. Management calculated that the cost per component is $7, so it is reluctant to accept this special order.

Problem Requirements Show how management came up with a cost of $7 per unit for this component. Evaluate this cost calculation. Explain why it is or is not appropriate. Should the offer from the Japanese firm be accepted? Why or why not?

Problem Solution Show how management came up with a cost of $7 per unit for this component. Calculate the cost per unit of manufacturing 50,000 component parts in the current year.

Problem Solution Cost per unit Direct material

Problem Solution Cost per unit Direct material $ 1.50 Given

Problem Solution Cost per unit Direct material $ 1.50 Direct labor

Problem Solution Cost per unit Direct material $ 1.50 Direct labor 1.50 Given

Problem Solution Cost per unit Direct material $ 1.50 Direct labor 1.50 Variable overhead

Problem Solution Cost per unit Direct material $ 1.50 Direct labor 1.50 Variable overhead 2.00 Given

Problem Solution Cost per unit Direct material $ 1.50 Direct labor 1.50 Variable overhead 2.00 Fixed overhead

Problem Solution Cost per unit Direct material $ 1.50 Direct labor 1.50 Variable overhead 2.00 Fixed overhead 2.00 Fixed overhead per unit = Total fixed overhead / Current units produced = $100,000 / 50,000 units

Problem Solution Cost per unit Direct material $ 1.50 Direct labor 1.50 Variable overhead 2.00 Fixed overhead 2.00

Problem Solution Cost per unit Direct material $ 1.50 Direct labor 1.50 Variable overhead 2.00 Fixed overhead 2.00 Cost per unit $ 7.00

Problem Solution Cost per unit Direct material $ 1.50 Direct labor 1.50 Variable overhead 2.00 Fixed overhead 2.00 Cost per unit $ 7.00 Solution: Cost per unit = $7.00

Problem Requirements Show how management came up with a cost of $7 per unit for this component. Evaluate this cost calculation. Explain why it is or is not appropriate. Should the offer from the Japanese firm be accepted? Why or why not?

Problem Solution The calculation includes an inappropriate unitization of fixed costs for decision making purposes. Unless the additional production of 30,000 units results in a movement to a new relevant range, total fixed expenses will not change.

Problem Requirements Show how management came up with a cost of $7 per unit for this component. Evaluate this cost calculation. Explain why it is or is not appropriate. Should the offer from the Japanese firm be accepted? Why or why not?

Problem Solution Should the offer from the Japanese firm be accepted? Why or why not? Analyze the relevant costs associated with producing an additional 30,000 units by accepting the special offer of $6 per unit.

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs:

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: The relevant costs of accepting this special offer are the incremental costs incurred by producing the additional 30,000 units.

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: Direct material

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: Direct material 1.50

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: Direct material 1.50 Direct labor

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: Direct material 1.50 Direct labor 1.50

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: Direct material 1.50 Direct labor 1.50 Variable overhead

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: Direct material 1.50 Direct labor 1.50 Variable overhead 2.00

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: Direct material 1.50 Direct labor 1.50 Variable overhead 2.00 Contribution margin per unit

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: Direct material 1.50 Direct labor 1.50 Variable overhead 2.00 Contribution margin per unit $ 1.00

Relevant Cost Analysis Problem Solution Relevant Cost Analysis Selling price $ 6.00 Less relevant costs: Direct material 1.50 Direct labor 1.50 Variable overhead 2.00 Contribution margin per unit $ 1.00 Note: Fixed costs are not relevant to this decision!

Problem Solution The offer should be accepted because it would generate contribution of $1 per unit or $30,000 total contribution. Since ICI was operating with idle capacity, and unless a more profitable opportunity were available for the use of the idle capacity, accepting the offer would increase profits by $30,000.

Accounting What the Numbers Mean 6e David H. Marshall Wayne W. McManus You should now have a better understanding of special pricing decisions. Remember that there is a demonstration problem for each chapter that is here for your learning benefit. David H. Marshall Wayne W. McManus Daniel F. Viele